Managerial Ability, Financial Distress, and Audit Fees

SYNOPSIS: This study examines whether the relationship between managerial ability and audit fees is conditional on financial distress. We find that higher managerial ability increases audit fees in financially distressed firms and decreases audit fees in non-distressed firms. We also observe that financially distressed firms with higher-ability managers display lower accrual quality and a higher likelihood of restatement. Moreover, higher-ability managers in distressed firms engage more in opportunistic financial reporting to concurrently maximize equity-based compensation and cope with debt refinancing pressures, which increases audit risks and results in greater audit fees. We confirm our results using a battery of sensitivity and additional analyses.