1. Agency problems and audit fees:
further tests of the free cash flow
hypothesis
TEAM PRESENTATION
WANG QI 42272645
GUO LIN 41948807
YU NING 41430581
JI DANDAN 42322723

2. OUTLINE
Main Aim Three Difficulties Conclusions and
Objectives limitations
• Introduction • Explanation
of the main • Demonstration of • Conclusions
aim of three hypotheses of this paper
objectives
in detail
• limitations/Ar
• Hypotheses eas need
raised in future
relation to these
objectives improvement

3. MAIN AIM
Provide further evidence on whether the audit fees vary in
relation to the agency problems in high FCF companies
Specifically, test whether high FCF companies with low
growth/high growth prospects have higher audit fees and
which mechanisms can mitigate the agency cost.

4. THREE MAIN OBJECTIVES
 1st objective: test the audit fees/high FCF
relationship
 Hypothesis 1 : Audit fees for high FCF
companies > low FCF companies’ audit fees.

5. THREE MAIN OBJECTIVES
 2nd objective: test whether debt is acting as a
monitoring mechanism that can reduce audit fees for
these high FCF companies
 Hypothesis 2: Audit fees for high FCF companies
low levels of debt > high levels of debt.

6. THREE MAIN OBJECTIVES
 3rd objective: whether dividend and share
repurchase can mitigate audit fees
 Hypothesis 3: Audit fees for high FCF companies
low level of dividends > high level of dividends
low share repurchase > high share repurchase

7. DIFFICULT TO UNDERSTAND
FCF hypothesis
Underlying assumption:
self-interest
Managers invest in non-
value maximizing projects
Lower level of efficiency

8. DIFFICULT TO UNDERSTAND
Debt -monitoring hypothesis
 funds available to managers
 debt holders monitor managers’ behaviors
 debt covenant

9. DIFFICULT TO UNDERSTAND
Audit fees relationship FCF Hypothesis
( Increase with higher audit risk & audit efforts)
High FCF/Low
High FCF/High growth
growth
Fund
growth More
internally intangible
Manager Manipul &
assets & Less Debt
s invest -ate Monitoring
Less
unwisely accounts capital Growth
market options
Monitoring

10. THREE IMPORTANT CONCLUSIONS
 Audit fees for High FCF companies(low growth and
high growth) are significantly higher than those for
low FCF companies.
 Audit fees vary negatively with debt for companies
with high FCF;
 However, No evidence to suggest that audit fees vary
negatively with dividends or share repurchase.

11. THREE WAYS OF IMPROVEMENT (LIMITATIONS)
 Samples used- US capital markets, where the agency
problem of FCF can be more significant for auditors than
elsewhere.
 Only supply-side explanation of the positive relation
between the agency problems of FCF and audit fees. May
consider other explanations;
 no comparison of audit fees between high FCF/ low
growth companies and high FCF/high growth companies