The auditors play a vital role in upholding the corporate governance standards in India. The external auditors are responsible for independently reviewing the financial statements of companies and provide opinion regarding its truthfulness and fairness. The auditing profession in the country is governed by the Institute of Chartered Accountants in India (ICAI), a statutory body established under an act of the Parliament of India. External auditors ensure that the regulators and investors maintain their faith in the functioning of the companies. The Indian companies have grown at a fast rate in the twenty first century both through mergers and acquisitions route as well as by product and geographical diversification. As businesses become large and complex; the job of the auditors becomes even more challenging. With rise in business complexity, the auditors also need to upgrade their knowledge spectrum in order to justify their role as independent monitors. It is likely that as audit assignment becomes more complex the auditors charge a higher fee for rendering their services.
The article analyzes the trend in auditor fee charged by auditors in India to gain insights about where the auditing industry is heading in terms of remuneration. We consider top 100 companies listed at the National Stock Exchange and trace them from 1999-2014. The Figure 1 gives graphical representation of the audit and non-audit fees paid by the top 100 companies in India during the period.
It is evident that both the average audit and non-audit fees have contributed towards an increasing trend in the auditor’s remuneration in the last 15 years. The average audit fees paid by the top 100 companies have grown more than 400 times and the non-audit fees have grown by more than 1000 times. In 1999, approximately 96 percent of the auditor’s remuneration comprised of audit fees and non-audit fees contributed mere 4 percent. The share of non-audit fee in auditor’s remuneration rose to 11 percent in 2014. The non-audit fee is still a small component of the auditor’s fee in India. It highlights that Indian companies appoints auditor essentially for regulatory compliance purposes and consulting for improving businesses is still at a nascent stage.
Next, based on the experience of the developed countries like the United States, United Kingdom and others, we look at some of the company characteristics which seem to drive the trend in audit and non-audit fees in India.
Larger companies incur higher audit and non-audit fees in India. The size of the company is an important aspect in the audit fee negotiation process between the auditor and the audited. When companies are large; they generally have various business segments and a large employee base. The audit team needs to spend more time to understand the internal functions of the large companies before issuing its audit reports. The additional time requirement is likely to be translated into higher audit fees being charged for audit assignment of large companies. The larger companies are also more likely to appoint auditors for availing non-audit services compared to others. Given its sheer size of operations, the management may feel that appointing auditors for process improvement purposes like identifying cost minimization opportunities can be helpful. This explains the positive relation between the size of the companies and the audit and non-audit fees incurred by the Indian companies in last 15 years as shown by figure 2.
The more profitable companies pay lower audit fee and avails more non-audit services than less profitable companies. It is often assumed that profitable companies are well-managed entities. The auditors associate low audit risk for companies making higher profits by charging lower audit fees. The audit fees and return on assets of the companies are negatively correlated during the period and has a coefficient of -0.19.
When companies earn higher accounting profits they are left with higher cash flow which can be used to avail non-audit services for further identifying business expansion strategies or tax planning. For the top 100 companies during the period of analysis, the non-audit fees and accounting profit given by return on assets has a positive correlation of 0.09. It suggests that even though the correlation exists, it is weak and higher profits occasionally translate into availing non-audit services in India.
Companies having debt to equity ratio pay higher audit fees and avails less non-audit services. The debt structure varies across companies and the median level of debt to equity ratio is 50 percent for the top 100 companies during the period. High levels of debt-equity ratio indicate the leverage position of the company. Auditors view leveraged businesses as risky audit candidates. As a result auditors may charge higher fees to audit companies having high debt-equity ratio. On the other hand, companies with high debt have less free cash flow to avail non-audit services even though corporate finance advisory provided by auditing firms can help them in restructuring their debt structure in future.
In India companies either belong to a business groups or are considered standalone entities. The audit fees paid by group companies are lower than standalone companies. The operations of the groups are characterized by complicated related party transactions of significant volume as well as value. The auditors are required to minutely analyze all such transactions to ensure that they are conducted on an arm’s length basis. Also, related party transactions are scrutinized in detail by the authorities in the country and poses great threat to the auditor for any misspecification in this regard. So, auditors are likely to charge higher fees for auditing group companies. However, the data suggests otherwise and the group companies are paying lower audit fees (average of 10.23 million rupees) than standalone entities (average of 74.86 million rupees). This can be on account of three factors. First, often one auditor is appointed for a number of companies belonging to one group and the group companies generally follow similar employee appraisal system, leave policies, etc. The audit team can leverage the knowledge obtained in one of the companies of the group while auditing the other companies in the same group. This reduces the effort and time which can lead to lower fees at the individual group company level. Secondly, the group companies have a reputation in the market and the auditors themselves want to associate with big groups for brand building purposes. This can also lead to charging lower fee for providing auditing services to group companies. Thirdly, the group companies having market power and reputation can negotiate lower fees with the auditor for the assignment in return of building long-term association across many firms in the group.
The multi-million Satyam accounting fraud in 2009 raised many corporate governance related questions in the country. The auditors (S. Gopalakrishnan and T. Srinivas) of PriceWaterhouse Coopers, which is among one of the Big 4 accounting firms; were also found guilty of colluding with the promoters of the company in inflating the books of accounts. ICAI cancelled their membership for lifetime and the judgment by the court on the Satyam case on April 9, 2015 also found the auditors guilty. The scam also influenced certain aspects of the new Companies Act, 2013 like inclusion of auditor rotation requirement to ensure greater independence. Rotation is likely to avoid formation of longstanding relation between the auditor and the client which can foster collusion (like in Satyam case).
In the post Satyam scam era the auditors have become more vigilant as informed investors now view audit reports critically and do not consider a clean report is a guarantee of fair practices being followed by the companies. The alertness on the part of the auditor is likely to be related with more detailed scrutiny of client’s operations which requires investing of more time by the auditor. This in turn led to a fee hike for audit processes. Also, post the scandal the companies are keener on appointing auditors for risk consulting purposes to signal the investors about the fair intentions of their companies. The period after the Satyam scandal the average audit fee increased from 20.75 million rupees to 44.57 million rupees.
In tandem with the United States and other developed countries in the west, the audit fees in India is related to company’s size, debt-equity ratio, reported loss in the previous year and profitability levels. It is likely that as companies in India grow at a healthy rate in the next few years, the audit fee will also move northwards. However, the group companies pay a lower audit fee in spite of business complexities indicating that the Indian market for auditor’s remuneration is driven by the market power of the clients to some extent. Finally, even though the non-audit services have grown over the years, it is still a small portion of the auditor’s remuneration pie. The Indian corporate sector majorly views the auditor as a monitor who signals the investor about the good corporate governance of the company and not as a facilitator of business. There is immense potential for collaboration between the companies and its auditors for non-audit services like tax planning, risk consulting, etc., which will help the companies to grow further. The audit firms need to create awareness among the companies about their portfolio of non-audit services and how it can help the client gain advantage over their competitors in the market. It is important to bring a paradigm shift from the current view of auditor as monitors to auditors as partners of growth. The big 4 firms are already catering to non-audit services of huge value, but it is necessary to enhance the demand of non-audit services which will be mutually beneficial for the companies as well as the auditing industry.
I am grateful to Dr. Subrata Sarkar for insightful discussions on corporate governance in India and IGIDR for providing the research infrastructure. I would like to thank my husband CA Jignesh Patel for his valuable inputs on the earlier draft version of this paper.