The Effects of Clients' Controversial Activities on Audit Pricing

We examine the effects of clients' involvement in controversial corporate activities on audit pricing. Clients' involvement in controversial activities raises concerns about management integrity and ethics. Moreover, clients involved in such activities are perceived to have higher risk of adverse financial performance. As a result, there is greater potential for financial misstatement, which increases the auditor's perceived business risk. We hypothesize that, given the higher perceived business risk, auditors charge higher fees to clients engaged in controversial activities. Using a unique dataset from Kinder, Lydenberg, and Domini, we identify clients that engage in controversial activities related to consumers, employees, the community, and the environment. Consistent with our hypothesis, we find that clients involved in controversial corporate activities pay higher audit fees compared to clients not involved in such activities