SSRN Id2878891

Proactive Financial Reporting Enforcement:
Audit Fees and Financial Reporting Quality Effects
Annita Florou
Department of Accounting
Bocconi University
Via Roentgen, 1
20136 Milano, Italy
Tel: +39 02 5836 2553
Email: annita.florou@unibocconi.it
Serena Morricone
SDA Bocconi School of Management
Via Bocconi 8
20136 Milano, Italy
Tel: +39 02 5836 6108
Email: serena.morricone@sdabocconi.it
Peter F. Pope ♣
Department of Accounting
Bocconi University
Via Roentgen, 1
20136 Milano, Italy
Tel: +39 02 5836 2550
Email: peter.pope@unibocconi.it
Pre-print version. Published in The Accounting Review: March 2020, Vol. 95, No. 2, pp. 167-197.
https://doi.org/10.2308/accr-52497
♣
Corresponding author: Peter Pope, peter.pope@unibocconi.it. Tel: +39 02 58362550. We would like to
thank the Editor, Clive Lennox, two anonymous reviewers, Hans Christensen, Joseph Gerakos, Robert
Knechel, Christian Leuz, Andrea Mennini, Antonio Parbonetti, Florin Vasvari, and participants at the
40th EAA Annual Congress for their helpful comments. Morricone wishes to thank Süleyman Ceran for
excellent research assistance.
Electronic copy available at: https://ssrn.com/abstract=2878891

Proactive Financial Reporting Enforcement:
Audit Fees and Financial Reporting Quality Effects
ABSTRACT
We examine the costs and benefits of proactive financial reporting enforcement by the UK
Financial Reporting Review Panel. Enforcement scrutiny is selective and varies by sector and
over time, yet can be anticipated by auditors and companies. We find evidence that increased
enforcement intensity leads to temporary increases in audit fees and more conservative accruals.
However cross-sectional analysis across market segments reveals that audit fees increase
primarily in the less-regulated AIM segment, and especially those AIM companies with a higher
likelihood of financial distress and less stringent governance. On the contrary, less reliable
operating asset-related accruals are more conservative in the Main segment, and in particular
those Main companies with stronger incentives for higher financial reporting quality. Overall,
our study indicates that financial reporting enforcement generates costs and benefits, but not
always for the same companies.
Keywords: audit fees; financial reporting quality; financial reporting enforcement; Financial
Reporting Review Panel.
JEL Classifications: K42, M41, M42, M48

Data Availability: Data are available from the public sources cited in the text.

I. INTRODUCTION
Numerous international studies suggest that institutional quality influences financial reporting
and market outcomes (see De George, Li and Shivakumar (2016) for a recent review). The
financial reporting enforcement system in a country is one potentially important element in its
institutional framework. Financial reporting enforcement aims to protect investors and promote
market confidence by ensuring that financial statements comply with applicable financial
reporting regulation, including accounting standards. In this paper, we examine the effects of
financial reporting enforcement by the UK’s regulatory body – the Financial Reporting Review
Panel (FRRP) – on compliance costs, partially captured by audit fees, and on financial reporting
quality, using accruals and their components.
Opportunities for causal studies of financial reporting enforcement effects are scarce because
time series or cross sectional variation in financial reporting enforcement is rare. Also, financial
reporting regulation is usually bundled with other indicators of institutional strength (e.g.,
judicial system, outsider protection, market monitoring, disclosure) and when financial reporting
enforcement change occurs there are often contemporaneous changes in other regulations
(Christensen, Hail, and Leuz 2013; Leuz and Wysocki 2016). Our study avoids most of these
problems by exploiting the novel financial reporting enforcement regime for UK listed
companies between 2004 and 2011. In 2004, the FRRP introduced proactive and selective
monitoring of published financial statements. In our sample period, the FRRP conducts annual
reviews of financial statements, but only targeted industry sectors, designated “priority sectors,”
are subject to proactive review each year. The FRRP publicly announces the priority sectors for
review towards the end of the previous year. The adoption of the proactive review strategy
represents a “clean” change in enforcement procedures resulting in increases in enforcement

intensity for companies in the targeted priority sectors. Under this proactive review system,
companies in priority sectors know in advance that their financial statements will potentially be
subject to increased enforcement scrutiny, while other companies in different sectors expect no
change or a reduction in the level of scrutiny of their financial statements. Consequently, we
expect to observe differences in audit pricing and financial reporting outcomes between
companies in FRRP priority sectors and those in other sectors. Moreover, FRRP enforcement
intensity changes are not bundled with other institutional changes; and if other relevant
institutional changes occur, they affect the incentives of all companies and their auditors.
Therefore, our experimental setting provides a novel opportunity to isolate the effects of
financial reporting enforcement on compliance costs and financial reporting quality.
We predict that increased enforcement scrutiny by the FRRP can result in both an increase in
compliance costs, partially captured by audit fees, and in financial reporting quality. These
consequences may arise due to both demand-side (i.e., preparer) and supply-side (i.e., auditor)
incentives (e.g., Ewert and Wagenhofer 2019). Using a large sample of UK non-financial listed
companies over the period 2000-2011 spanning the introduction of the priority review system in
2004 to the cessation of public announcements of priority sectors, we report a number of results
that are new to the literature. Audit fees increase by 6.8 percent on average in years when
companies are subject to proactive FRRP review, after controlling for other standard audit fee
determinants. The increase in audit fees is transitory, dependent on cumulative enforcement
scrutiny, and in particular limited to two years in the cases of sectors subject to FRRP review in
multiple consecutive years. In the case of accruals, our initial analysis reveals no overall
significant FRRP enforcement effects on accruals and their components, after controlling for
other standard accruals determinants.

Next, we predict differences in FRRP enforcement effects for companies in the London Stock
Exchange’s Main market segment (Main) and the Alternative Investment Market (AIM)
segment. We expect differences across market segments because AIM companies are more
lightly regulated (e.g., they are subject to less EU regulations) and have different innate
characteristics (e.g., they tend to be younger and more financially constrained) when compared
to Main segment companies (Gerakos, Lang, and Maffett 2013). Accordingly, a company’s
market segment may be a relevant determinant of its auditor’s engagement risk as well as the
company’s propensity for higher financial reporting quality. We find that audit fees increase by
8.3 percent for AIM companies when they are under FRRP review, whereas there is no
corresponding enforcement effect on the audit fees of Main companies. When we examine FRRP
enforcement effects on accruals, we document a reduction in total operating accruals for Main
companies exceeding 2 percent of total assets, but there is no corresponding effect on accruals of
AIM companies. Further analysis reveals that less reliably measured accruals components
requiring judgment, estimation and managerial discretion are lower when companies are under
FRRP enforcement scrutiny. Hence, the significant accruals effects for Main segment companies
are primarily concentrated in operating rather than financing accruals, long-term rather short-
term accruals, and accruals affecting assets rather than those affecting liabilities. Taken together,
these findings suggest that Main companies potentially subject to FRRP review adopt more
conservative accounting whereas the corresponding AIM companies incur higher compliance
costs, when compared to companies in non-targeted sectors.
Then, we perform further cross-sectional tests to investigate the drivers of the enforcement
effects on financial reporting quality for Main companies; and on audit costs for AIM
companies. We show that only Main companies with stronger incentives for higher quality

financial reporting (i.e., those with lower probability of default or those with independent audit
committees) respond to increased enforcement through more conservative accruals. Similarly,
we find that the audit fee enforcement premium is borne only by AIM companies with higher
client business risk (i.e., higher default probability) or those with higher audit risk (i.e., those
without fully independent audit committees). These latter findings indicate that client business
risk and audit risk are important factors in auditors’ pricing decisions when their clients are faced
with intensified enforcement. Accordingly, our findings suggest that auditors do not act
strategically when their clients are in FRRP priority sectors. Instead, they appear to price their
services according to risk-related client factors (Causholli and Knechel 2012).
To the best of our knowledge, our paper is the first to study the impact of changes in financial
reporting enforcement on compliance costs and financial reporting quality. In this respect, our
paper extends prior literature that establishes the consequences of bundled changes in auditing,
governance and financial reporting enforcement regulations on compliance costs and reporting
quality. For example, a number of papers document increased audit fees after the enactment of
the Sarbanes-Oxley Act (SOX) (e.g., Ghosh and Pawlewicz 2009; Iliev 2010; Alexander,
Bauguess, Bernile, Lee, and Marietta-Westberg 2013). Another stream of studies reports more
timely loss recognition (Lobo and Zhou 2006), lower accruals-based earnings management (e.g.,
Cohen, Dey, and Lys 2008; Koh, Matsumoto, and Rajgopal 2008) and more conservative
accruals (Iliev 2010) following the SOX regulation (see Leuz and Wysocki (2016) for a related
review). Similarly, He, Pan, and Tian (2015) and Lesage, Ratzinger-Sakel, and Kettunen (2017)
report a premium in audit fees associated with other country-specific regulatory changes. Our
study contributes beyond this prior literature because it provides sharper identification of
financial reporting enforcement effects by exploiting the time series and cross sectional

heterogeneity in enforcement resulting from the FRRP’s priority sector methodology. Moreover,
FRRP enforcement intensity changes are not bundled with other institutional changes whereas
other relevant contemporaneous regulatory changes either affect all UK companies
simultaneously, or in the case of the staggered introduction of IFRS, are explicitly controlled for
in our research design.1
Our paper also complements other recent research addressing different aspects of financial
reporting enforcement change. Hitz, Ernstberger, and Stich (2012) examine the market reaction
to financial reporting error detection by the German enforcement body (the Deutsche Prüfstelle
für Rechnungslegung). Perhaps unsurprisingly they report an overall average negative market
reaction to announcements of error detection, suggesting that the enforcer detects errors that the
market does not fully anticipate. Related research by Ernstberger, Stich, and Vogler (2012)
report some evidence that financial reporting enforcement reform in Germany leads to lower
earnings management as well as higher stock market liquidity and valuations. Our paper
complements these studies by exploiting a cleaner setting of changes in financial reporting
enforcement; by finding that financial reporting enforcement affects both financial statement
quality and compliance costs; and by documenting cross-sectional variation in enforcement
effects depending on companies’ engagement risk and incentives for high quality financial
reporting.
Finally, our paper is also related to a contemporaneous study by Christensen, Liu, and Maffett
(CLM) (2019) exploiting the same quasi-experimental setting as ours. Their primary focus is on
investigating the effect of FRRP enforcement intensity on shareholder wealth. They report that
1
IFRS adoption is mandatory for Main segment companies in financial years commencing on or after December
2005; and for AIM segment companies in financial years commencing on or after January 2007. For further details,
see: https://www.iasplus.com/en/jurisdictions/europe/uk. Therefore, the mandatory IFRS adoption date for UK
companies varies depending on market segment and the fiscal year-end.

FRRP priority sector announcements reduce equity values, suggesting that the enforcement
reforms in the UK have a net negative effect on shareholder wealth. In contrast, we focus on the
implications of the UK enforcement reforms for compliance costs and financial reporting quality.
We believe that it is important for understanding the origins of any possible enforcement effects
on shareholder wealth (or other market outcomes such as liquidity) to have comprehensive
evidence on the costs and benefits of enforcement reforms. Since the FRRP’s enforcement
scrutiny focuses on financial reporting outcomes, we contribute relevant evidence on regulatory
compliance costs, in the form of audit fees, and on financial reporting benefits captured by
accruals behavior.2
In the next section, we provide an overview of the institutional setting and the relevant
literature. In Section III, we elaborate on our research design and empirical specifications, and in
Section IV, we describe the data and present our main empirical findings. In Section V, we
report our sensitivity tests, and we conclude in Section VI.
II. BACKGROUND
Institutional Setting
Financial reporting enforcement in the UK has been the responsibility of the FRRP since
1991. The primary objective of the FRRP is to ensure that the provision of financial information
by public listed and large private companies complies with statutory accounting requirements
and applicable accounting standards. Until 2004 the FRRP adopted a reactive approach to the
2
CLM (2019) also study FRRP enforcement effects on audit fees, although their analysis is less comprehensive and
they do not study financial reporting quality. We attempted to replicate the main shareholder wealth analysis of
CLM using only unadjusted raw returns (i.e., without adjusting for foreign sector returns). CLM report a statistically
significant negative announcement effect of -16.08 basis points (see their Table 4, Panel A, Model 2). However,
using the same data source (Datastream) and experimenting with alternative sample definitions (e.g., including or
excluding financial sector companies) we are unable to confirm the net negative effect of FRRP enforcement
intensity on shareholder wealth reported by CLM. But, we note that our findings may not be directly comparable to
those of CLM due to different research design choices relating to sample selection process, the treatment of outliers
and the mapping of ICB industry sectors.

detection of defective financial reporting, relying on complaints made by third parties (e.g.,
individuals, corporate bodies, analysts and press commentary) to trigger investigations.3 In 2004
the FRRP announced a change in its strategy to include proactive reviews. The proactive review
approach involves a program of review of financial statements based on risk assessment. In
addition, each year the FRRP focuses on targeted priority sectors of the economy. Each year
during October-November between 2004 and 2011 the FRRP announces publicly the priority
sectors identified for review in the next year. Hence, managers and auditors of companies know
before the fiscal year end whether their financial statements will be subject to increased FRRP
enforcement scrutiny.4 We assume that FRRP announcements apply to financial statements for
fiscal periods ending between December in the FRRP announcement year and November in the
next year.
Appendix 1 lists the FRRP priority sectors, the announcement dates and the financial
statement periods under review; it also details the number of proactive reviews undertaken and
the number of approaches to companies made by the FRRP (analogous to SEC comment letters)
each year.5 The descriptive data suggest that the overall level of FRRP enforcement activity grew
over the eight-year period. Our empirical analysis is restricted to non-financial sectors, several of
3
The FRRP was established in 1990 as a subsidiary of the Financial Reporting Council (FRC). For a detailed
historical review of the FRRP prior to 2004 see Brown and Tarca (2007). Following a major restructuring in 2013
financial reporting enforcement now falls under the direct remit of the Conduct Committee of the Financial
Reporting Council.
4
The FRRP does not disclose the names of companies selected for review. In addition to the industry in which the
company operates, the risk-based selection process considers the probability of non-compliant reporting and the
potential impact of any errors on the company. The risk-based approach may also be prompted by specific topical
accounting issues that are considered important or problematic, as well as by complaints from the public, the press
and the City. The risk-based selection is supplemented by an element of random sampling (see
https://www.frc.org.uk/Our-Work/Corporate-Governance-Reporting/Corporate-Reporting-Review/How-we-review-
reports-and-accounts.aspx). Our sample period ends in 2011 when the FRRP stops announcing priority sectors.
5
Approaches to companies refer to cases where the FRRP writes to a company’s chairman raising an identified
reporting issue of concern to FRRP. These cases are not publicly disclosed but typically the vast majority of the
matters raised are satisfactorily addressed by the company without the need for further action. We collect
information regarding the relevant statistics from press releases and annual activity reports prepared by the FRRP
available at https://www.frc.org.uk/Our-Work/Corporate-Governance-Reporting/Corporate-Reporting-
Review/Annual-activity-reports.aspx.

which are targeted multiple times and in consecutive years: retail, utilities, travel and leisure,
media, house builders, and support services. However, 19 sectors are not subject to proactive
review during 2004-2011 – we denote these sectors as “never targeted”. We exploit the diversity
in sector selection in our empirical analysis.
In the event that the FRRP identifies egregious financial reporting deficiencies the most
common sanction is to require financial statements to be restated (including amendments to
disclosures); companies usually undertake such restatements voluntarily. If the FRRP requires
revisions to financial statements, companies also make a public announcement. In less severe
cases of financial reporting deficiencies, the FRRP avoids public disclosure and reaches an
agreement with companies on corrective action, often only requiring adjustments to financial
reporting practices in future years. Accordingly, the relatively small number of public press
releases identifying financial reporting deficiencies in Appendix 1 should not necessarily be
interpreted as evidence of high quality financial reporting, or as evidence of ineffective
enforcement. However, FRRP sanctions are potentially costly to both companies and auditors,
who know the targeted priority sectors before financial statements are prepared. Thus, low
numbers of reported financial reporting deficiencies might also reflect increased effort by
preparers and auditors resulting in higher quality, compliant financial statements.
Prior Literature and Hypotheses

Enforcement, Audit Costs and Financial Reporting Quality
We predict that increased enforcement scrutiny by the FRRP can result in both an increase in
compliance costs, partly measurable as audit fees, and in financial reporting quality. These
consequences may arise due to both demand-side (i.e., preparer) and supply-side (i.e., auditor)
incentives (e.g., Ewert and Wagenhofer 2019). A company’s priority sector status is important
because if the FRRP identifies financial reporting deficiencies the company can suffer adverse

capital market consequences, particularly when net asset values and income are overstated (e.g.,
Ahmed, Billings, Morton, and Harris 2002; Palmrose, Richardson, and Scholz 2004); and
increased (financial) contracting costs (e.g., Graham, Li, and Qui 2008). Therefore we expect
companies under FRRP review to have stronger incentives to issue higher quality financial
statements by making more conservative accruals choices.6 Further, to the extent that companies
rely on auditors to reduce financial reporting deficiencies, when they belong to a FRRP priority
sector they are likely to demand higher auditor effort and greater auditor expertise and
experience, hence incurring higher audit costs.7
Auditor incentives are also likely to change when a client is subject to FRRP review. In the
event of an adverse FRRP review the auditor may suffer reputational costs; and litigation costs
could also increase, especially if an adverse review coincides with financial distress. In the
absence of mitigating actions by the auditor, expected auditor business risk (Wang and Chui
2015) and residual risk (DeFond and Zhang 2014) increase when the auditee belongs to a priority
sector. DeFond et al. (2016) suggest that auditors expect lower engagement risk when accounting
is more conservative. Therefore the auditor can attempt to mitigate FRRP-related risk by
pressing for higher quality financial statements, and in particular more conservative accruals; this
may require additional auditor effort and/or a higher quality audit engagement team, both of
which increase audit fees. The auditor can also price-protect by charging a fee premium to
mitigate higher expected engagement risk. Increasing auditor effort and the quality of the
6
Accruals will be lower due to increased enforcement scrutiny if enforcement discourages aggressive accounting for
current year transactions and if it encourages correction of any overstatements of net asset values due to aggressive
accounting in previous years.
7
The audit fee literature identifies two components of the total cost of an audit: (i) the cost of auditor effort; and (ii)
the expected costs of legal liability (Simunic 1980). Also, prior research documents higher audit fees for auditor
expertise and specialization (e.g., Goodwin and Wu 2014).

engagement team, and charging a fee premium are not mutually exclusive strategies for the
auditor (DeFond and Zhang 2014).
In our empirical tests we employ audit fees and accruals, respectively, to proxy for
compliance costs and financial reporting quality. 8 Accordingly, we formulate our first and
second hypotheses as follows:
H1: Ceteris paribus, audit fees increase for companies in FRRP priority sectors.
H2: Ceteris paribus, accruals are lower for companies in FRRP priority sectors.
Cross-Sectional Variation in Enforcement Effects

We focus on a company’s stock market segment as a potentially important proxy capturing
overall engagement risk and financial reporting quality. Companies subject to FRRP
enforcement scrutiny belong to one of two segments of the London Stock Exchange (LSE) – the
Main market (Main) and the Alternative Investment Market (AIM); the two groups of companies
differ due to regulatory and company-specific factors (which, of course, may be related to each
other). Main market companies are required to comply with higher standards of disclosure and
governance, including all European Union (E.U.) securities regulations whereas AIM companies
are subject to a lower level of mandated regulation and are exempt from many E.U. regulatory
provisions (Gerakos et al. 2013). The company-specific factors relate to the different business
model and life cycle characteristics. AIM companies on average are younger, smaller, more
8
Ideally, one would like to examine the regulatory findings of the FRRP enforcement, including the quality of
financial statement information provided by companies reviewed or approached by the FRPP or asked to take
corrective actions. However, as discussed, FRRP does not publicly disclose this information and, as a result, we are
not able to observe the outcomes of the FRRP enforcement per se. In addition, other commonly studied outcome
variables in the audit and financial reporting quality literatures, such as accounting restatements and litigation, are
not available for UK companies from available databases. Consequently, we conduct our analysis of financial
reporting quality based on accruals proxies, for which data is available.
10

financially constrained and less profitable but with higher growth prospects.9 Next, we discuss
how the FRRP enforcement effects may vary between Main and AIM companies in light of their
differences.
Audit costs effects
Causholli and Knechel (2012) argue that audit services exhibit credence good attributes.
Expert auditor-sellers have an information advantage over client-buyers concerning the planning
and conduct of audits because of their idiosyncratic and uncertain nature. As a result, clients
cannot be certain about the level of assurance they require or that initially promised by the
auditor. When companies belong to FRRP priority sectors and are faced with the possibility of
increased enforcement, auditors could therefore attempt to exploit their informational advantage
by strategically increasing audit fees without considering engagement risk. If, on average,
auditors price audit services as credence goods, we would expect audit fees to be systematically
higher for companies in FRRP priority sectors and not to depend on the level of engagement risk.
The alternative audit pricing perspective suggests that in equilibrium auditors earn fees in
return for bearing risk and for expending audit effort. Client engagement risk consists of three
main components: (i) client business risk, i.e. the risk related with the client’s survival and
profitability; (ii) auditor business risk, i.e. the risk of potential reputational and litigation costs
from an alleged audit failure; and (iii) audit risk, i.e. the risk that a material misstatement may be
undetected by the auditor (DeFond et al. 2016). This perspective underpins most empirical
models of audit fees (see Hay, Knechel, and Wong (2006) for a related review). We therefore use
this framework to develop tests of whether FRRP enforcement effects on audit fees depend on
specific sources of engagement risk.
9
See http://www.londonstockexchange.com. Also, unreported statistics confirm that Main and AIM companies in
our sample differ on several characteristics; for example, AIM companies have lower total assets, ROA and cash
flows as well as higher probability of making losses and higher sales and PPE growth.
11

We conjecture that AIM companies subject to FRRP review have higher engagement risk for
two main reasons. First, AIM companies have a higher likelihood of financial distress and
business failure since they are smaller, less profitable and more financially constrained – hence
we expect client business risk to be higher for AIM companies, on average. Second, AIM
companies are less likely to invest in sophisticated financial reporting and internal control
systems because they are smaller and more financially constrained and also, on average, have
weaker corporate governance due to lighter regulation – hence we expect audit risk to be higher
for AIM companies, on average.10 In contrast, we expect Main companies to have higher auditor
business risk because they are relatively large and the overwhelming majority is audited by Big
N firms.11
While we expect market segment to capture differences in the components of engagement
risk, in our empirical tests we also examine whether cross-sectional differences in client business
risk and audit risk within market segment are relevant in auditors’ pricing decisions when their
clients are faced with increased enforcement. We use the probability of default as our proxy for
client business risk and audit committee independence as our proxy for audit risk. However,
finding a company-level proxy for auditor business risk is challenging for empirical researchers
because company-level proxies for reputational and litigation risk are elusive (Minutti-Meza
2014). Consequently, we are unable to examine possible cross-sectional enforcement effects due
to auditor business risk differences within the two market segments.12
10
Consistent with our priors, unreported statistics document that our sample AIM companies (compared to Main
companies) are subject to a higher probability of default and have weaker governance structures, such as less
independent audit committees.
11
The larger client base of Big N auditors subjects them to greater reputation damage and their “deep pockets”
subject them to higher litigation exposure (DeFond and Zhang 2014).
12
A small number of prior studies examine the role of auditor business risk in audit pricing by exploiting litigation
risk differences across countries (e.g., Kim, Liu, and Zheng 2012) or by using a proxy for perceived auditor business
risk based on survey responses (Bell, Landsman and Shackelford 2001). However, in our empirical setting we have
no available instruments capturing company-level litigation risk beyond company and audit firm size. In our sample
12

Financial reporting quality effects
A company’s pre-audited financial reporting quality is a function of (i) innate characteristics
affecting the ability of financial statements to reflect the underlying economics of the business;
and (ii) the financial reporting system affecting the company’s ability to detect or prevent a
material error (DeFond and Zhang 2014). Also, numerous prior studies identify several motives
related to financial statement credibility, including the likelihood of financial distress and the
quality of the governance mechanisms (see Lin and Hwang (2010) and Walker (2013) for related
reviews).
We argue that Main companies subject to FRRP review are more likely to produce higher
quality financial statements. As discussed, Main companies tend to be larger, more profitable and
less likely to default; they also have more developed internal controls and more rigorous
corporate governance provisions. Therefore, Main companies facing increased FRRP scrutiny
are more likely to respond by generating more credible financial reports. In line with these
arguments, Ewert and Wagenhofer (2019) develop a model predicting that in a high intensity
enforcement regime, greater enforcement mitigates managers’ incentives for earnings
management due to increased penalties. In contrast, AIM companies are younger and smaller
with higher growth opportunities; prior literature documents that these innate factors are
associated with lower accruals quality (Dechow and Dichev 2002; Francis, LaFond, Olsson, and
Schipper 2005). Moreover, AIM companies have less financial resources and operate in a less
stringent governance and regulatory environment. Accordingly, the ability and incentives of
AIM companies to react to intensified FRRP monitoring by providing higher quality financial
classifying Big N-audited large companies as having higher auditor business risk results in almost no variation in
auditor business risk within the Main market segment. This is mainly because the Main audit market is dominated
by Big N auditors (91% of the sample Main companies are audited by a Big N auditor compared to 57% of AIM
companies); as a result, there are no large companies in FRRP priority sectors audited by a smaller auditor within
the Main segment.
13

reporting might be limited, at least in the short term. Accordingly, in our empirical tests we
employ market segment, as well as the probability of default and the audit committee
independence within market segment, to capture differential enforcement effects on financial
reporting quality.
In sum, we predict that the audit costs and financial reporting effects of FRRP enforcement
may vary depending on a company’s market segment listing. Accordingly, in our empirical
analysis we examine the effects of FRRP targeting for Main and AIM companies relative to
companies in non-targeted sectors. We then extend our analysis to consider the enforcement
related effects for the two groups of companies conditioning on certain company factors that
proxy for specific sources of client business risk and audit risk as well as for preparer incentives.
III. RESEARCH DESIGN
FRRP Proactive Review Treatment Variable
To capture the effects of the FRRP proactive review enforcement activity we define a binary
treatment variable (FRRP) that equals 1 if the company’s sector is announced as a priority sector
in Fall of year t and the fiscal year-end is between December of year t and November of year t+1,
and 0 otherwise. We follow the FRRP in using the Industrial Classification Benchmark (ICB)
taxonomy for classifying companies into sectors, and then we map the ICB industry sectors onto
the priority sectors announced by the FRRP over the 2004-2011 period.13 Appendix 2 details our
mapping process. Following Christensen, Hail, and Leuz (2013) we treat 2005 as the first year of
FRRP proactive review, even though the initial phase of proactive reviews occurred in 2004. The
rationale for this choice is that in 2004 the FRRP adopted a “broad-based” approach when
13
We collect time series data on companies’ ICB industry codes from the LSE website and then we manually match
this information with other data using company names.
14

selecting financial statements for review whereas in subsequent years it fully implemented a new
risk-based monitoring method.
Empirical Models
To examine the effect of FRRP enforcement on audit fees we estimate the following model:
Fees = α0 + α1 FRRP + ∑19

𝑗=1 𝛾𝑗 Firm-Specific Controls + FFE + YFE + ε (1)
In Equation (1) Fees is measured as the natural logarithm of audit fees, and FFE and YFE
indicate firm and year fixed effects, respectively. The firm fixed effects specification uses each
company as its own control and also takes account of unobservable firm- and sector-specific
factors, hence increasing confidence that our estimates capture changes in the outcome variables
conditional on the enforcement status of companies. The coefficient estimate α1 captures the
average change in audit fees for company-years in FRRP priority sectors (i.e., the treated
company-years) relative to all other company-years not under review. The control variables in
Equation (1) include a broad set of audit fee determinants established in the prior literature
including Size, BusSegments, GeoSegments, ForeignSales, InvReceiv, Impairments, Acquisition,
Qualified, ROA, Loss, Quick, Leverage, December, BigAuditor, NegativeEquity, M/B,
AuditorChange and IFRS (e.g., Kim et al. 2012; Carcello and Li 2013; DeFond et al. 2016). We
also include a binary variable, AIM, to control for possible differences in audit pricing between
Main and AIM companies not captured by the other determinants.14 Appendix 3 describes in
detail the construction of all variables used in the study.
14
As discussed, differential audit pricing between AIM and Main companies could reflect their different level of
engagement risk. Moreover, audit fee differences between AIM and Main companies could be due to the latter being
subject to more onerous auditing requirements. For example, under the listing requirements for the Main Market,
auditors have an additional duty to review whether the corporate governance statement reflects compliance with the
provisions of the Combined Code and to report if it does not (e.g. PwC 2018). Consequently, we would expect
incremental effort being expended on the audits of companies quoted on the Main Market. However, there is no
reason to expect that audit effort in relation to non-financial reporting compliance would increase for FRRP targeted
companies, given that the FRRP remit is concerned with financial reporting issues. We obtain annual data on a
company’s stock market segment from the LSE website (see
15

To test whether FRRP enforcement is associated with accruals, we estimate the following
model:
Accruals = 0+ 1FRRP + ∑12

𝑗=1 𝛿𝑗 Firm-Specific Controls + FFE + YFE + v (2)
Accruals is defined as different components of total accruals, measured as all changes in non-
cash balance sheet items and hence capturing the combined effects of accounting for new
transactions and re-measurements of balance sheet amounts brought forward from previous
years.15 The coefficient estimate 1 captures the average change in accruals for company-years in
FRRP priority sectors (i.e., the treated company-years) relative to all other company-years not
under review. The control variables in Equation (2) include a broad set of accruals determinants
documented in prior research including Size, Loss, Leverage, December, BigAuditor, M/B, IFRS,
CFO, CFOVolatility, SalesGrowth and PPEGrowth (e.g., Lennox and Li 2012; Carcello and Li
2013; Ahmed, Neel, and Wang 2013). We also include AIM to control for possible differences in
accruals between Main and AIM companies that are not captured by the other control variables.
To strengthen identification in estimating Equation (2) we examine a number of accruals
components based on the accruals typology of Richardson, Sloan, Soliman and Tuna (2005).
These components differ in the reliability of measurement of underlying balance sheet items and
http://www.londonstockexchange.com/statistics/companies-and-issuers/companies-and-issuers.htm). Since this data

does not provide any company identification codes, we manually match companies from the LSE website with those
in our Worldscope dataset using company names.
15
Prior research examines accruals using various constructs including total accruals (e.g., Healy 1985) or models
decomposing total accruals into abnormal and normal components, usually relative to other companies in the same
industry (e.g., Dechow, Sloan and Sweeney 1995). We focus on total accruals rather than abnormal accruals for two
reasons. First, prior research argues that auditors are more concerned with the total accruals (Lys and Watts 1994);
and audit work, audit adjustments and related negotiations focus on the actual level of accruals (Nelson, Elliott and
Tarpley 2002). Second, our research objective is to identify the average FRRP enforcement effect across treated
company-years, after controlling for known firm-level determinants of accruals. Noted that there is no company-
level variation in the FRRP variable for any given treated industry-year (i.e., priority sector-year); and within
industry-years adjusted accruals measures (e.g., industry-adjusted or abnormal accruals), by construction, average
zero. Therefore, if we were to industry adjust accruals then we would “throw out the baby with the bathwater.”
16

reflect differences in the importance of estimates and judgments in accruals measurement. We
first decompose total accruals as follows:
T_ACC ≡ TOP_ACC + FIN_ACC ≡ WC_ACC + NCO_ACC + FIN_ACC (3)
where T_ACC is total accruals, TOP_ACC is total operating accruals, FIN_ACC is financial
accruals, WC_ACC is current operating accruals and NCO_ACC is non-current operating
accruals. All accruals variables are scaled by total assets at the beginning of the year. Based on
Richardson et al. (2005) we predict that current operating accruals are more reliably measured
than non-current operating accruals; and that financial accruals are more reliable than operating
accruals components. In additional analyses we further decompose the main accruals
components in Equation (3) into changes in the respective asset and liability accounts, predicting
that changes in liabilities are more reliably measured than changes in assets. If FRRP
enforcement results in higher quality financial reporting we predict a reduction in the less
reliably measured accruals components for companies in priority sectors. Hence we expect that
more conservative accounting induced by FRRP enforcement will show up in operating accruals
components (and especially non-current operating accruals) rather than financial accruals and in
asset-related accruals rather than liability-related accruals.
As discussed, we examine the cross-sectional enforcement effects between Main and AIM
companies and after conditioning on two variables capturing company-level engagement risk and
financial reporting incentives. Specifically, we employ the probability of default (PD) from a
structural credit model as a measure of financial distress and therefore of client business risk.
The PD measure comes from the Risk Management Institute (RMI) at the National University of
Singapore (see, www.rmicri.org; Duan and Wang 2012). We use an indicator for audit
committee independence (IndAC) as a proxy for internal governance structures and thus for audit
17

risk. In line with prior literature (Lin and Hwang 2010) we consider an audit committee to be
independent in two ways: a) if more than 50% of its members are classified as independent (i.e.,
proportional independence); and b) if 100% of its members are outsiders (i.e., complete
independence); information is collected primarily from BoardEx and supplemented by
governance data of Manifest Ltd.
All other financial statement data is collected from Worldscope. Information regarding audit
firm identity and audit opinion are obtained from Company Analysis and Capital-IQ and
supplemented with hand-collected data from annual financial statements. For further details see
Appendix 3. Continuous variables are winsorized at the 1st and 99th percentiles except for
variables with natural upper or lower bounds. In all models we report White-corrected standard
errors clustered at the firm level.
Sample Selection
Our initial sample of 2,709 companies (18,021 firm-years) includes all UK domiciled
companies listed on the Main and AIM segments of LSE between 2000 and 2011.16 We then
exclude companies belonging to the financial sector because their financial information is not
comparable to that of other companies, and more importantly because the timing of FRRP
proactive reviews for the banking sector coincides with the global financial crisis period (i.e.,
2007 and 2008). The final audit fee sample with the necessary data to estimate Equation (1)
comprises 1,928 companies (13,249 firm-years). The accruals sample with necessary data for
estimating Equation (2) comprises 1,666 companies (10,434 firm-years).
16
Using Worldscope we select companies based on the major securities and primary market codes. We then exclude
foreign domiciled companies with securities cross-listed in London and those domiciled in the Crown Dependencies
(e.g., Isle of Man, Jersey), using ISIN codes to determine the country of domicile.
18

IV. EMPIRICAL RESULTS
Audit Fees
In Table 1, Panels A and B respectively we provide breakdowns of our audit fees sample by
year and by industry (using the three-digit ICB code); in each case we also show the sample split
between Main and AIM segments as well as between targeted and non-targeted subsamples.
Panel A indicates that over the 2005-2011 proactive review period an average of approximately
17 percent of companies is included in priority sectors (=1,275/7,638) with the proportion
varying across years between 12 percent in 2008 (=130/1,088) and 23 percent in 2006
(=285/1,241). Panel B shows that the intensity of proactive enforcement also varies considerably
across industries, with 19 industries never being targeted for proactive review (e.g., chemicals,
industrial engineering, oil and gas producers) while others are targeted quite intensively (e.g.,
food and drug retailers, general retailers). Companies in the never-targeted sectors along with
companies in targeted sectors but not under review in a given year constitute the control group in
our research design. The sample is quite evenly split across the Main and AIM market segments.
In Panel C of Table 1, we report descriptive statistics for all variables used in estimating
Equation (1). We also present mean values of the variables for the FRRP enforcement period
2005-2011 for the following subsamples: (i) targeted sector observations in review years; (ii)
targeted sector observations in non-review years; and (iii) never-targeted sector observations.
The final three columns of Panel C indicate whether the differences between mean values for
each subsample pair is statistically significant.17 When we compare target sector companies in
review years against target sector companies in non-review years, Panel C reveals preliminary
17
Tests of significance are based on regression of each variable on FRRP and year fixed effects, where standard
errors are clustered at the sector-year level (based on three-digit ICB codes). This approach controls for systematic
time-series variation in the variables and for lack of independence of observations within sector-years due to FRRP
selection being at the sector level.
19

univariate evidence that audit fees are higher for companies when they are under review; these
companies are also larger and more profitable with lower foreign sales, less likely to receive a
qualified audit opinion and to change auditors. When we compare targeted companies against
company-years in never-targeted sectors, we observe similar differences.18
In Panel D of Table 1, we report the regression analyses based on Equation (1) showing the
impact of FRRP enforcement on audit fees. In Model 1 we show the overall FRRP effect on
audit fees in our sample (Hypothesis 1). The estimated coefficient on FRRP is 0.066 and highly
significant, suggesting a 6.8 percent increase in audit fees in years when companies are in a
FRRP priority sector.19 Overall the audit fee model behaves in line with expectations; control
variable loadings are generally consistent with prior studies and the model has good explanatory
power. In Model 2 we investigate whether the FRRP effect differs according to the stock market
segment. We divide all FRRP observations in each year into two non-overlapping subsets,
conditioning on the market segment; the coefficients on FRRP_Main and FRRP_AIM capture the
total FRRP enforcement effects on audit fees for Main and AIM companies respectively. The
results indicate that the enforcement premium in audit fees observed for the overall sample is
driven by AIM segment companies; the coefficients on both FRRP_Main and FRRP_AIM are
positive, but statistically significant only in the case of the AIM segment where the economic
effect is equivalent to an 8.3 percent average increase in audit fees in FRRP review years.
In Table 2 we report additional analyses shedding light on the dynamics of the FRRP
enforcement effects on audit fees. These tests give greater insights into the timing and
persistence of enforcement effects on audit fees, especially when there are repeated proactive
18
As discussed, the inclusion of firm fixed effects in our regression analysis mitigates concerns that such differences
could affect inferences regarding the FRRP enforcement treatment effect. Also, in Section V we report that our main
results are insensitive to the inclusion of never-targeted sectors in the control group.
19
We calculate the economic significance of FRRP based on the antilog of the 0.066 estimate.
20

reviews of a sector. In the interest of brevity, the full set of control variables described earlier is
included in all models but we do not report coefficient estimates for these variables. We perform
the dynamic analysis in two ways.
First, in Panel A we examine whether the documented FRRP audit fee premium increases
with the intensity of the enforcement scrutiny. In Model 1 we replace FRRP by a new variable
FRRP_Times defined as the count of the number of times (years) a sector has been targeted by
the FRRP.20 We also introduce the quadratic term of FRRP_Times2 to allow for the possibility
that the marginal effect on audit fees of repeated targeting declines as the cumulative targeting
count increases. Results suggest that audit fees increase with repeated FRRP targeting but that
the marginal effect declines as the cumulative enforcement scrutiny intensifies (i.e., in Model 1
FRRP_Times is highly positive and FRRP_Times2 is negative).21 Next, in Model 2 we test
whether the effects of repeated targeting depends on the size of targeted sectors; intuitively, the
greater the number of companies within a sector the lower the likelihood a company will be
selected (assuming that the resources available for FRRP enforcement effort do not increase
proportionally to the size of targeted sectors). Accordingly, in Model 2 we weight both
FRRP_Times and the corresponding quadratic term by the number of companies in the sector-
year. Controlling for the size of the sector, Model 2 yields similar results although economic
interpretation is less intuitive because of the weighting by sector size.
In Panel B, we employ an alternative research design to capture the dynamics of repeated
FRRP reviews. In Model 1 we test whether in addition to the contemporaneous FRRP effect on
20
Given that our FRRP period spans over 2005-2011, the theoretical range of FRRP_Times is from 0 (never
targeted) to 7 (repeatedly targeted over the entire period). The actual range of this variable in our sample is from 0 to
5 (i.e., the maximum total number of all repeated, consecutive and non-consecutive, reviews is five years for the
Retail sector; see Appendix 2).
21
Interpreted literally and assuming that FRRP_Times is independent of other control variables, the coefficients on
FRRP_Times and FRRP_Times2 imply that the expected effect of repeated targeting on audit fees reaches a
maximum just less than three repeated FRRP reviews (i.e., 𝜕(𝐹𝑒𝑒𝑠)⁄𝜕(𝐹𝑅𝑅𝑃𝑇𝑖𝑚𝑒𝑠 ) = 0 when FRRP_Times =
0.073/(2 x 0.013) = 2.81).
21

audit fees (FRRP) there is any anticipation effect of the first-time selection of a sector for FRRP
scrutiny by including an indicator for the last year before first-time FRRP targeting
(Last_Before); any recalibration of audit fees following a series of FRRP reviews and prior to
further, but non-consecutive, FRRP reviews (Between); and any persistent enforcement effect on
audit fees in the period after FRRP review periods (First_After). In Model 2 we decompose the
contemporaneous FRRP enforcement effect into the average effect for FRRP reviews conducted
once only or with repeated, consecutive reviews (FRRP_Once&Consecutive) and non-
consecutive repeated reviews (FRRP_NonConsecutive). In Model 3 we then isolate the effect of
first-year reviews (FRRP_FirstYear) and the effect of subsequent consecutive reviews
(FRRP_Consecutive). Finally, in Model 4 we disaggregate FRRP_Consecutive into effects for
each year in repeated sequences of consecutive inspections, namely FRRP_Consecutive_Y2
capturing the second consecutive year review effect, FRRP_Consecutive_Y3 capturing the third
consecutive year effect and FRRP_Consecutive_Y4 capturing the fourth consecutive year
effect.22 The column headed N indicates the number of company-years in each targeted sector
subsample.
Collectively, the findings in Panel B reveal several new insights concerning the dynamics of
FRRP enforcement effects on audit fees, as follows. First, audit fees do not change in
anticipation of FRRP review (i.e., Last_Before is insignificant). Second, audit fees are not
recalibrated during the intervening years between repeated FRRP sector reviews (i.e., Between is
either insignificant or at best marginally significant at the 10 percent level); and the enforcement
premium in audit fees is transitory (i.e., First_After is always insignificant). These results
22
For example, the Travel sector is under review in 2006, 2007, 2008 and 2010. In this case, Last_Before=1 in 2005;
FRRP=1 in 2006-2008 and 2010; Between=1 in 2009; First_After=1 in 2011; FRRP_Once&Consecutive=1 in 2006-
2008; FRRP_NonConsecutive=1 in 2010; FRRP_FirstYear=1 in 2006; FRRP_Consecutive=1 in 2007 and 2008;
FRRP_Consecutive_Y2 and FRRP_Consecutive_Y3 equal 1 in 2007 and 2008, respectively.
22

indicate that the audit fee enforcement premium disappears in the years when the FRRP
enforcement switches to other sector(s). Third, results indicate that there is no increase in audit
fees for companies in sectors that are subsequently reviewed again but not consecutively (i.e.,
FRRP_NonConsecutive is insignificant). Finally, in the case of repeated and consecutive
monitoring, the audit fee also increases in the second year of review but not in subsequent years
(the coefficients on FRRP_FirstYear and FRRP_Consecutive_Y2 are respectively 0.057 and
0.143 and statistically significant, whereas the coefficients on FRRP_Consecutive_Y3 and
FRRP_Consecutive_Y4 are insignificant).23 These latter results are broadly consistent with the
quadratic specification based on the cumulative enforcement indices in Panel A.
Accruals
In Table 3, Panels A and B we report sample properties analogous to Table 1 for the accruals
sample. In Panel C we report descriptive statistics for all variables used in estimating Equation
(2), along with subsample analysis similar to Table 1. Similar to Table 1, when we compare
targeted sector companies in review years with targeted sector companies in non-review years,
Table 3, Panel C reveals preliminary univariate evidence that accruals are lower when companies
are under review, but this is only true for operating accruals and its components. Similar to Table
1, Panel C also indicates a small number of differences in the characteristics of companies in
never-targeted sectors.
In Panel D of Table 3, we report regression results based on Equation (2) showing the impact
of FRRP enforcement on accruals and accruals components. We note that the predicted level of
reliability is lower for TOP_ACC, WC_ACC and NCO_ACC than for FIN_ACC (Richardson et
23
Our finding on First_After is not directly comparable to results in CLM (2019, see their Table IA5, Panel B), who
document that the audit fee increase remains persistently higher in subsequent years. This is because the equivalent
FRRP variable of CLM (2019), i.e., FREt=2..n, is coded 1 for all years subsequent to the first FRRP review year,
irrespective of whether there is a repeated FRRP sector review. Also, we note that all FRRP-related findings
remain unchanged after dropping the non-FRRP variables (i.e., Last-before, Between and First_After).
23

al. 2005). Similar to the audit fees analysis, we estimate the overall FRRP enforcement effect
(Hypothesis 2) as well as the differential FRRP effects for Main and AIM companies.
The estimated coefficients on FRRP in accruals models for the full sample are mostly
negative, but always insignificant at conventional levels (Models 1, 3, 5, 7 and 9). However,
when we estimate separate accruals FRRP enforcement effects for each market segment, the
coefficients on FRRP_Main are negative and economically and statistically significant for total
operating accruals, and especially for the non-current operating accruals component (Models 2,
4, 6, 8 and 10); in contrast, FRRP_AIM is always insignificant. To illustrate, when companies in
the Main market segment are subject to FRRP priority review, after controlling for the standard
determinants of accruals, total operating accruals decrease by 2.1 percent of lagged total assets
on average and non-current operating accruals decrease by 1.6 percent on average. Our finding
of more conservative accruals behavior in priority sectors is consistent with companies acting to
reduce possible overstatements of assets, especially those measured less reliably, when they
know they are subject to review. Results on control variables are largely consistent with prior
research, suggesting primarily that larger companies with higher growth display higher accruals.
Table 4 extends the analysis of FRRP enforcement effects on accruals by further decomposing
operating accruals into changes in the underlying assets (TOA_ACC, WCA_ACC, and
NCOA_ACC) and the underlying liabilities (TOL_ACC, WCL_ACC, and NCOL_ACC). Again, in
the estimation we include the full set of control variables described earlier, but to conserve space
we do not report coefficient estimates. Based on Richardson et al. (2005) we expect lower levels
of reliability in the measurement of assets than liabilities and hence more pronounced
enforcement effects on asset-related accruals than liability-related accruals. Consistent with the
results in Table 3, the results of Table 4 indicate more conservative (or less aggressive) accruals
24

for Main companies subject to FRRP enforcement when accruals reliability is lower (i.e., for
assets rather than liabilities accruals). Again there are no significant FRRP effects for AIM
companies.24
Taken together, empirical results for the overall sample reported in Tables 1 and 3 support
Hypothesis 1 but fail to confirm Hypothesis 2. However, our analysis reveals cross-sectional
variation in the FRRP enforcement effects across stock market segments. Our findings indicate
that FRRP enforcement is associated first with temporary increases in audit fees for companies in
FRRP sectors, and especially for AIM companies; and second, with more conservative accruals,
but only for Main companies. We now examine whether there is cross-sectional heterogeneity in
these enforcement effects related to company-level factors associated with engagement risk and
preparer incentives.
Further Cross-Sectional Analysis
In Table 5 we present the results of further cross-sectional tests. We include all control
variables described earlier, but for brevity we do not report their coefficient estimates. In Panel A
we investigate the FRRP enforcement effects conditioning on the probability of default,
transforming PD into a binary indicator based on the sample median. We classify targeted Main
and AIM companies into groups with relatively high or low probability of default (i.e., HighPD
and LowPD respectively).25
As before we find evidence of an audit fee enforcement premium only for AIM companies,
but we now see that it is only those with high default probability where the effect is significant;
24
In the case of accruals we do not perform dynamic analyses for two main reasons. First, evidence of FRRP effects
on accruals in later years could reflect enforcement actions by the FRRP, rather than preparer or auditor anticipation
of enforcement. Second, the literature provides little guidance on modelling the dynamics of accruals. Establishing
accruals dynamics is challenging for several reasons including accruals reversals, cumulative effects of past accruals
decisions, variation in companies’ cash conversion cycles and future economic performance.
25
Results remain qualitatively unchanged if we use the median PD value by market segment.
25

the estimate of FRRP_AIM_HighPD is 0.110 and highly significant, whereas all other FRRP
estimates are insignificant (Model 1). We also find that the observed decline in accruals is
concentrated in Main companies in FRRP sectors, with the effect being limited to companies
with low default probability; for example, the estimate on FRRP_Main_LowPD is -0.032 for
total operating accruals and this is significant at the 1% level, whereas all other FRRP estimates
are insignificant (Models 2–4). Overall, findings in Panel A suggest that financial distress is an
important risk factor considered in audit pricing of targeted AIM companies; and FRRP
enforcement enhances financial reporting quality only for financially healthier Main companies.
In Panel B we examine the FRRP enforcement effects for Main and AIM companies
conditioning on audit committee independence (i.e., IndAC and NonIndAC). We present results
based on both the proportional audit committee independence measure (Models 1–4) and the
more conservative complete audit committee independence proxy (Models 5–8). As the
subsample sizes indicate, only very few Main targeted companies (32 company-years) are
classified as having non-independent audit committees using the proportional independence
definition. Again, we report total enforcement effects for the subsamples of companies within
each market segment with independent or non-independent audit committees, using the two
definitions.
For audit fees, Models 1 and 5 confirm the results in Table 1, Panel D showing no
enforcement premium for Main companies - conditioning on audit committee independence does
not affect this conclusion. However, for AIM companies results depend on the definition of audit
committee independence. Model 1 indicates that the FRRP enforcement premium is present for
both AIM companies with independent and with non-independent audit committees, defining
independence as a majority of independent directors on the committee; in this case both
26

FRRP_AIM_IndAC and FRRP_AIM_NonIndAC are positive (0.076 and 0.089 respectively) and
significant at less than the 10% level, but they are not statistically different (i.e., the p-value of
the difference of the two estimates is 0.825). In contrast, Model 5 indicates that if we classify
companies more conservatively based on whether the audit committee is completely
independent, the audit fee enforcement premium is borne only by AIM companies with non-
independent audit committees; FRRP_AIM_NonIndAC is 0.098 and significant at less than the
5% level while the enforcement premium for companies with completely independent audit
committees, FRRP_AIM_IndAC, is not different from zero. These results suggest that the quality
of internal governance and, in particular, the audit committee composition of AIM targeted
companies is priced by auditors as a significant source of engagement risk, with the evidence
pointing to audit committees including one or more non-independent members being treated as
higher risk.
With respect to accruals, Models 2–4 and 6–8 are very consistent in showing that the more
conservative accruals by Main companies in FRRP priority sectors are attributable to the
companies with independent audit committees; the estimate of FRRP_Main_IndAC is
significantly negative for each accruals component studied, while all other estimates of FRRP
effects are insignificant. Results are also insensitive to the definition of audit committee
independence. These results suggest that Main companies with more stringent internal
governance and, in particular, with (partially or completely) independent audit committees adopt
more conservative accruals when they expect increased enforcement scrutiny from the FRRP.
Collectively the regression results reported in Tables 1, 3 and 5 suggest that increased FRRP
enforcement intensity is associated with both higher audit costs and more conservative accruals.
More importantly, our analysis indicates that Main companies respond to the threat of increased
27

FRRP enforcement through less aggressive accruals; and that auditors do not seek an audit fee
enforcement premium from these companies. The documented decline in accruals is observed
only for Main companies with stronger incentives to improve their financial reporting and thus,
avoid the negative consequences of an adverse FRRP review. Conversely, AIM companies in
FRRP priority sectors do not react to the threat of enforcement scrutiny through more
conservative accruals choices; but they do pay higher audit fees. This is particularly the case for
AIM companies with higher client business risk or higher audit risk. Overall, our findings
suggest that auditors do not act strategically when their clients are in FRRP priority sectors.
Instead, they appear to price their services according to risk-related client factors (Causholli and
Knechel 2012).
V. SENSITIVITY ANALYSIS
Endogeneity
Non-random selection of priority sectors by the FRRP creates a risk of observing false
positive treatment effects if the independence assumption is violated and unobserved variables
affect both the selection and the outcome variable(s) of interest. Consistent with this argument,
CLM (2019) model the selection of the FRRP priority sectors using specific observables,
although their sector selection models have low explanatory power, suggesting a high degree of
randomness in the selection process.
Nonetheless, we attempt to address concerns about possible endogeneity biases in two ways.
First, we include firm fixed effects that capture unobserved sector characteristics influencing
FRRP sector selection and the outcome variables. Second, similar to CLM (2019) we assess the
sensitivity of our main findings to introducing potential sector and company selection predictors
as additional control variables, including company and industry stock returns in the year to the
28

FRRP announcement date; and firm-level and industry-level restatements in the year prior to the
priority sector announcement date. Untabulated analysis reveals that all our primary inferences
remain unchanged. Overall, the difficulty in finding powerful predictors of FRRP priority sector
selection itself, and our sensitivity analyses provide some reassurance that endogeneity problems
may not be severe. However, we acknowledge that we are not able to fully control for the
potential endogeneity of the FRRP treatment variable.
Other Robustness Tests
To assess the robustness of our main findings reported in Tables 1 and 3 we perform a series
of additional tests. First, we exclude the never-targeted sectors from the control group; or
alternatively we include indicators capturing the change in outcome variables in never-targeted
sectors during the FRRP enforcement period. Second, we replace firm fixed effects by ICB
(subsector) industry fixed effects and cluster standard errors at the industry level. Results
reported in Table 6 confirm our primary tests. We also assess the sensitivity of our findings to:
the assumption that the FRRP reviews begin in 2004 instead of 2005; alternative mappings of
FRRP priority sectors onto ICB sectors;26 excluding U.S. cross-listed companies because they
are subject to SEC enforcement and SOX; and including a lagged FRRP indicator to allow for
the possibility that audit fees are renegotiated or adjusted with a lag. Untabulated analyses
indicate that all our main findings are qualitatively unchanged.
VI. SUMMARY AND CONCLUSIONS
We provide causal evidence on the effects of financial reporting enforcement on audit fees – a
regulatory compliance cost; and on the conservatism of accruals components – a financial
reporting quality outcome. We find evidence of an economically significant, but transitory,
26
Specifically, we redefine priority sector “Information Technology” as super-sector “9500 Technology”;
“Transport” to also include sub-sectors “5751 Airlines” and “5759 Travel & Tourism”; and “Travel” as super-sector
“5700 Travel & Leisure.” The alternative mappings have a trivial effect on the number of targeted firm-years.
29

increase in audit fees overall, with these incremental compliance costs being borne by companies
in the more lightly regulated AIM market segment. We also find an economically significant
decline in accruals overall, especially accruals components that are less reliably measured, and
only for Main market segment companies. Our results are consistent with preparers in the Main
market segment responding to increased enforcement risk through more conservative accruals
choices; this is particularly the case when Main companies are relatively healthy or when they
have higher quality audit committees. In contrast, there is no such accounting quality response by
AIM companies; instead these companies are charged higher audit fees when under FRRP
review, and in particular when they are more likely to experience financial distress or when they
have lower quality audit committees.
Our results are consistent with the broader regulatory environment and differences in innate
company characteristics being important in determining preparer and auditor responses to
increased financial reporting enforcement. Accordingly, our results suggest cross-sectional
differences in compliance costs and in financial reporting benefits. To the extent that these costs
and benefits are relevant we would expect cross-sectional differences in related equity market
consequences. Overall, our findings are potentially relevant to policy makers and regulators with
interests in assessing the consequences of enforcement innovation.
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32

Appendix 1: FRRP Proactive Review Activity
Financial
Announcement statements Accounts Approaches Press
Sectors under review
date under reviewed* to companies notices
review
12/04-
12/21/04 Retail Automobile Utility Pharmaceutical Transport 135 58 3
11/05
12/05-
12/12/05 Retail Automobile Utility Pharmaceutical Transport 195 112 4
11/06
12/06- Travel-
12/11/06 Retail Utility Telecommunications Media 116 99 2
11/07 Leisure
12/07- Travel- Commercial House
11/09/07 Retail Banking 188 96 2
11/08 Leisure property builders
12/08- Travel- Commercial House
10/30/08 Retail Banking 186 136 3
11/09 Leisure property builders
12/09- Commercial Information
12/09/09 Advertising Recruitment Media 219 133 4
11/10 property technology
12/10- Commercial Support
11/25/10 Insurance Travel 221 122 0
11/11 property services
12/11- Commercial Support
12/09/11 Retail 264 91 1
11/12 property services
*Proactive accounts reviews refer only to annual accounts of listed LSE companies with the exception of financial statement year 2011 where the equivalent statistic includes
both annual and interim accounts reviewed. Financial sectors (excluded from our analysis) are shown in italics.
33

Appendix 2: Mapping of the ICB Industry Sectors onto the FRRP Priority Sectors
FRRP
ICB sectors and subsectors Year
priority sector
Retail 533 Food & Drug Retailers 2005, 2006, 2007, 2008,2011
537 General Retailers
Automobile 335 Automobiles & Parts 2005
Utility 753 Electricity 2005, 2006
757 Gas, Water & Multi-utilities
Pharmaceutical 457 Pharmaceuticals & Biotechnology 2005
Transport 277 Industrial Transportation 2005
Travel-Leisure 575 Travel & Leisure 2006, 2007, 2008
Travel Subsector 5759 Travel & Tourism within Sector 575 Travel & Leisure 2006, 2007, 2008 under Travel-Leisure 2010
Telecommunications 653 Fixed Line Telecommunications 2006
657 Mobile Telecommunications
Media 555 Media 2006, 2009
Advertising Subsector 5555 Media Agencies within Sector 555 Media 2006 within Media, 2009
House builders Subsector 3728 Home Construction within Sector 372 Household Goods & Home 2007, 2008
Construction
Information technology 953 Software & Computer Services 2009
Support services 279 Support Services 2010, 2011
Recruitment Subsector 2793 Business Training & Employment Agencies within Sector 279 2009, 2010, 2011 within Support services
Support Services
34

Appendix 3: Variable Definitions (with Worldscope item numbers in parentheses)
Variable Definition
Outcome variables
Fees The natural logarithm of audit fees in British Pounds (WC01801).
FIN_ACC Financial accruals calculated as FINt – FINt-1 deflated by average total assets. FIN is
defined as Financial Assets (FINA) - Financial Liabilities (FINL), where FINA =
Short-Term Investments [Cash and Short-Term Investments (WC02001) – Cash
(WC02003)] + Long-Term Investments [Long Term Receivables (WC02258) +
Investment in Associated Companies (WC02256) + Other Investments (WC02250)]
and FINL = Long-term debt (WC03251) + Debt in Current Liabilities (WC03051) +
Preferred Stock (WC03451).
NCO_ACC Non-current operating accruals calculated as NCOt – NCOt-1 deflated by average total
assets. NCO is defined as Non-Current Operating Assets (NCOA) - Non-Current
Operating Liabilities (NCOL).
NCOA_ACC Non-current operating assets accruals calculated as NCOAt – NCOAt-1 deflated by
average total assets. NCOA is defined as Total Assets (WC02999) - Current Assets
(WC02201) - Long-Term Investments [Long Term Receivables (WC02258) +
Investment in Associated Companies (WC02256) + Other Investments (WC02250)].
NCOL_ACC Non-current operating liabilities accruals calculated as NCOLt – NCOLt-1 deflated by
average total assets. NCOL is defined as Total Liabilities (WC03351) - Current
Liabilities (WC03101) – Long-term debt (WC03251).
T_ACC Total accruals calculated as the sum of current operating accruals (WC_ACC), non-
current operating accruals (NCO_ACC) and financial accruals (FIN_ACC)
(Richardson et al., 2005).
TOA_ACC Total operating assets accruals calculated as TOAt – TOAt-1 deflated by average total
assets. TOA is defined as Current Operating Assets (WCA) + Non-Current Operating
Assets (NCOA).
TOL_ACC Total operating liabilities accruals calculated as TOLt – TOLt-1 deflated by average
total assets. TOL is defined as Current Operating Liabilities (WCL) + Non-Current
Operating Liabilities (NCOL).
TOP_ACC Total operating accruals calculated as the sum of current operating accruals
(WC_ACC) and non-current operating accruals (NCO_ACC) (Richardson et al.,
2005).
WC_ACC Current operating accruals calculated as WCt – WCt-1 deflated by average total assets.
WC is defined as Current Operating Assets (WCA) - Current Operating Liabilities
(WCL).
WCA_ACC Current operating assets accruals calculated as WCAt – WCAt-1 deflated by average
total assets. WCA is defined as Current Assets (WC02201) - Cash and Short-Term
Investments (WC02001).
WCL_ACC Current operating liabilities accruals calculated as WCLt – WCLt-1 deflated by average
total assets. WCL is defined as Current Liabilities (WC03101) - Debt in Current
Liabilities (WC03051).
Treatment variables
Between An indicator variable equal to 1 for companies in sectors that are not under FRRP
review in the current year but that are under to review in at least one year both before
and after the current year, 0 otherwise.
First_After An indicator variable equal to 1 for companies in sectors under last-time FRRP
review in the previous year, 0 otherwise.
FRRP An indicator variable equal to 1 for companies in sectors under FRRP review in the
current year, 0 otherwise.
35

FRRP_AIM An indicator variable equal to 1 for AIM segment companies in sectors under FRRP
review in the current year, 0 otherwise.
FRRP_AIM_ An indicator variable equal to 1 for AIM segment companies in sectors under FRRP
HighPD review and with a high probability of default (PD) in the current year, 0 otherwise.
Companies are classified as high PD if the corresponding PD value is equal to or
higher than the sample median value. The PD measure comes from the Risk
Management Institute (RMI) at the National University of Singapore. For more
details, see www.rmicri.org, and Duan and Wang (2012). We employ the same
indicator for Main segment companies.
LowPD review and with a low probability of default (PD) in the current year, 0 otherwise.
Companies are classified as low PD if the corresponding PD value is lower than the
sample median value. We employ the same indicator for Main segment companies.
IndAC review and with an independent audit committee in the current year, 0 otherwise.
Companies are classified as having an independent audit committee if more than 50%
of its members are independent (i.e., proportional independence) or if 100% of its
members are independent (i.e., complete independence). Data is taken from BoardEx
and Manifest Ltd. We employ the same indicator for Main segment companies.
NonIndAC review and with a non-independent audit committee in the current year, 0 otherwise.
Companies are classified as having a non-independent audit committee if 50% or less
of its members are independent or if 100% of its members are not independent. We
employ the same indicator for Main segment companies.
FRRP_Consecutive An indicator variable equal to 1 for companies in sectors under a repeated
consecutive FRRP review, 0 otherwise.
FRRP_Consecutive An indicator variable equal to 1 for companies in sectors under FRRP review for the
_Y2 second consecutive year, 0 otherwise.
_Y3 third consecutive year, 0 otherwise.
_Y4 fourth consecutive year, 0 otherwise.
FRRP_FirstYear An indicator variable equal to 1 for companies in sectors under first-time FRRP
review, 0 otherwise.
FRRP_Main An indicator variable equal to 1 for Main segment companies in sectors under FRRP
review in the current year, 0 otherwise.
FRRP_Never An indicator variable equal to 1 for companies in sectors never subject to FRRP, 0
otherwise.
FRRP_Never_AIM An indicator variable equal to 1 if FRRP_Never equals 1 and the company is in the
AIM segment, 0 otherwise. We employ the same indicator for Main segment
companies.
FRRP_NonConse- An indicator variable equal to 1 for companies in sectors under repeated non-
cutive consecutive FRRP review, 0 otherwise.
FRPR_Once&Con- An indicator variable equal to 1 for companies in sectors under FRRP review in the
secutive current year either as a one-time review or as one of a series of consecutive reviews,
0 otherwise.
FRRP_Times Count of how many times (years) the company’s sector has been subject to FRRP
review. The theoretical range of FRRP_Times is from 0 to 7.
FRRP_Times- Count of how many times (years) the company’s sector has been subject to FRRP
Weighted review, weighted by the total numbers of companies in each sector-year.
Last_Before An indicator variable equal to 1 for companies in sectors under first-time FRRP
36

review in the following year, 0 otherwise.
Control variables
Acquisition Indicator variable equal to 1 if the company is engaged in an acquisition reporting an
increase in goodwill (WC18280), 0 otherwise.
AIM An indicator variable equal to 1 if the company is listed on AIM in the current year, 0
otherwise.
AuditorChange Indicator variable equal to 1 if the company changes audit firm, 0 otherwise.
BigAuditor Indicator variable equal to 1 if the company is audited by a Big audit firm (Arthur
Andersen; Deloitte; EY; Grant Thornton; KPMG; PWC), 0 otherwise.
BusSegments Natural log of 1 plus the number of business segments (WS19503-WS19593).
CFO Operating cash flow (WC04860) scaled by lagged total assets (WC02999).
CFOVolatility Two years rolling standard deviation of operating cash flow (CFO).
December Indicator variable equal to 1 for companies with a December fiscal year-end
(WC05350), 0 otherwise.
ForeignSales Ratio of foreign sales (WC07101) to net sales (WC01001).
GeoSegments Natural log of 1 plus the number of geographical segments (WS19603-WS19693).
HighPD Indicator variable equal to 1 if the company’s probability to default (PD) is equal to
or higher than the sample median value, 0 otherwise.
IFRS An indicator variable equal to 1 if the company reports under IFRS in the current
year, 0 for UK GAAP (WC07536).
Impairments Indicator variable equal to 1 for companies reporting an impairment loss on goodwill
(WC18225), intangible assets (WC18226), PPE (WC18274), financial assets
(WC18275), 0 otherwise.
IndAC Indicator variable equal to 1 if more than 50% of the company’s audit committee
members are independent (i.e., proportional independence), 0 otherwise; or if 100%
of the company’s audit committee members are independent (i.e., complete
independence), 0 otherwise.
InvReceiv The sum of inventories (WC02101) and receivables (WC02051) divided by total
assets (WC02999).
Leverage Ratio of long-term debt (WC03251) to total assets (WC02999).
Loss Indicator variable equal to 1 if the company reports a negative net income
(WC01706) in the current year, 0 otherwise.
M/B Market-to-Book calculated as ratio of market value (WC08002) over book value of
equity (WC03501).
NegativeEquity Indicator variable equal to 1 if the company is reporting a negative book value of
equity (WC03501), 0 otherwise.
PPEGrowth PPE increase (or decrease) from year t-1 to year t scaled by lagged PPE (WC02501).
Qualified Indicator variable equal to 1 if the company obtains a qualified audit opinion, 0
otherwise.
Quick Quick Ratio (WC08101).
ROA Return on assets ratio (WC08326).
SalesGrowth Sales increase (or decrease) from year t-1 to year t scaled by lagged sales
(WC01001).
Size The natural log of total assets (WC02999).
37

Table 1: FRRP and Audit Fees
Panel A: Sample Distribution by Year
Year Total Main AIM Target Non-Target
2000 1,170 850 320 0 1,170
2001 1,143 786 357 0 1,143
2002 1,084 713 371 0 1,084
2003 1,069 652 417 0 1,069
2004 1,145 601 544 0 1,145
2005 1,217 535 682 177 1,040
2006 1,241 480 761 285 956
2007 1,197 455 742 147 1,050
2008 1,088 427 661 130 958
2009 1,003 407 596 201 802
2010 964 390 574 145 819
2011 928 377 551 190 738
Total 13,249 6,673 6,576 1,275 11,974
38

Panel B: Sample Distribution by Industry
Non- Non-
Industry Total Main AIM Target Industry Total Main AIM Target
Target Target
Aerospace & Defense 150 131 19 0 150 Industrial Engineering 542 345 197 0 542
Alternative Energy 98 21 77 0 98 Industrial Metals & 83 18 65 0 83
Mining
Automobiles & Parts 75 44 31 7 68 Industrial 227 157 70 21 206
Transportation
Beverages 99 69 30 0 99 Leisure Goods 106 49 57 0 106
Chemicals 227 154 73 0 227 Media 1,030 407 623 168 862
Construction & Materials 446 309 137 0 446 Mining 853 152 701 0 853
Electricity 79 31 48 18 61 Mobile 95 31 64 12 83
Telecommunications
Electronic & Electrical 526 250 276 0 526 Oil & Gas Producers 588 191 397 0 588
Equip.
Fixed Line 140 82 58 12 128 Oil Equip., Services 125 63 62 0 125
Telecommunications & Distribution
Food & Drug Retailers 115 97 18 40 75 Personal Goods 240 159 81 0 240
Food Producers 311 202 109 0 311 Pharmaceuticals & 635 254 381 63 572
Biotechnology
Forestry & Paper 22 12 10 0 22 Software & Computer 1,480 576 904 100 1,380
Services
Gas, Water & Multi- 127 116 11 20 107 Support Services 1,824 915 909 311 1,513
utilities
General Industrials 171 122 49 0 171 Technology Hardware 375 223 152 0 375
& Equip.
General Retailers 697 508 189 257 440 Tobacco 30 30 0 0 30
Health Care Equip. & 385 158 227 0 385 Travel & Leisure 951 529 422 226 725
Services
Household Goods & 397 268 129 20 377 Total 13,249 6,673 6,576 1,275 11,974
Home Construction
39

Panel C: Descriptive Statistics (N=13,249)
Full Sample Post-2004
Target Target Not- Never
Diff Diff Diff
Mean Q1 Median Q3 SD Under review Under review Target
(a-b) (a-c) (b-c)
(a) (b) (c)
Fees 5.109 3.951 4.883 6.040 1.602 5.423 5.136 4.987 ++ ++
AIM 0.496 0.000 0.000 1.000 0.500 0.540 0.602 0.616 − −
IFRS 0.486 0.000 0.000 1.000 0.500 0.845 0.831 0.851
Size 10.929 9.336 10.742 12.299 2.279 11.395 10.846 10.810 ++ ++
ForeignSales 0.279 0.000 0.074 0.545 0.346 0.205 0.255 0.400 −− −− −−
ROA -0.063 -0.084 0.031 0.081 0.301 -0.019 -0.060 -0.079 + ++
Leverage 0.109 0.000 0.035 0.176 0.150 0.139 0.120 0.083 ++ ++
InvReceiv/TA 0.278 0.097 0.242 0.417 0.214 0.265 0.255 0.268
M/B 2.620 0.874 1.655 3.120 5.082 2.742 2.641 2.539
Quick 2.254 0.600 0.960 1.680 4.513 1.401 1.746 3.388 −− −−
BusSegments 0.778 0.693 0.693 1.099 0.557 0.870 0.854 0.818
GeoSegments 0.777 0.000 0.693 1.386 0.600 0.755 0.783 0.864 −− −−
Loss 0.417 0.000 0.000 1.000 0.493 0.348 0.388 0.461 −− −
Qualified 0.036 0.000 0.000 0.000 0.187 0.031 0.048 0.077 − −− −
BigAuditor 0.724 0.000 1.000 1.000 0.447 0.733 0.712 0.647 ++ ++
AuditorChange 0.052 0.000 0.000 0.000 0.222 0.058 0.075 0.082 − −−
December 0.428 0.000 0.000 1.000 0.495 0.378 0.428 0.488 −
Impairments 0.275 0.000 0.000 1.000 0.446 0.326 0.285 0.326
Acquisition 0.365 0.000 0.000 1.000 0.482 0.380 0.421 0.319 ++ ++
NegativeEquity 0.064 0.000 0.000 0.000 0.244 0.071 0.089 0.043 ++ ++
PD 0.005 0.001 0.002 0.005 0.016 0.007 0.006 0.005 ++
IndAC (proportional) 0.669 0.000 1.000 1.000 0.470 0.693 0.663 0.646
IndAC (complete) 0.497 0.000 0.000 1.000 0.500 0.551 0.525 0.500 +
40

Panel D: Regression of Audit Fee Model
1 2
FRRP 0.066*** -
2.67
FRRP_Main - 0.050
1.19
FRRP_AIM - 0.080***
2.60
AIM -0.114*** -0.116***
-3.11 -3.15
IFRS 0.106*** 0.109***
3.89 4.02
Size 0.482*** 0.482***
29.82 29.82
ForeignSales 0.063* 0.063*
1.69 1.68
ROA -0.003*** -0.003***
-8.58 -8.59
Leverage 0.087 0.088
1.33 1.34
InvReceiv 0.327*** 0.327***
4.63 4.62
M/B 0.001 0.001
1.01 1.03
Quick -0.010*** -0.010***
-4.58 -4.58
BusSegments 0.057** 0.057**
2.09 2.08
GeoSegments 0.046** 0.045**
2.29 2.30
Loss 0.056*** 0.056***
3.33 3.35
Qualified 0.038 0.038
1.15 1.14
BigAuditor 0.094** 0.094**
2.51 2.51
AuditorChange 0.021 0.021
1.00 1.00
December 0.134*** 0.133***
2.73 2.72
Impairments 0.039*** 0.039***
2.59 2.59
Acquisition 0.029** 0.029**
2.17 2.17
NegativeEquity 0.090** 0.090**
2.14 2.14
Intercept -0.605*** -0.604***
-3.37 -3.36
N 13,249 13,249
Adjusted R2 0.90 0.90
This table presents the audit fee sample distribution by year (Panel A) and by industry sector based on the three-digit
41

ICB code (Panel B). In both panels we decompose the sample into Main and AIM as well as into targeted and non-
targeted firm-years. Panel C reports the distributional properties of all variables used in the audit fee analysis for the
entire sample as well as separately for the subsamples comprising of targeted under review, targeted not under
review, and never-targeted observations in the post-2004 period; we note that the number of firm-years in the case of
PD and IndAC is 11,373 and 11,352 respectively due to additional missing observations. Tests of significance are
based on regression of each variable on FRRP and year fixed effects, where standard errors are clustered at the
sector-year level (based on three-digit ICB codes). ++ (− −), and + (−) denote significance at the 1% and 5% levels,
respectively (two-tailed test).
Panel D reports the coefficient estimates based on versions of Equation (1), as follows:
Fees = α0 + α1 FRRP + ∑19𝑗=1 𝛾𝑗 Firm-Specific Controls + FFE + YFE + ε (1)
The sample includes all UK domiciled companies listed on the LSE between 2000 and 2011. The dependent variable
Fees is the natural logarithm of audit fees in thousands of British Pounds. FRRP is an indicator variable equal to 1
for companies in sectors under FRRP review in the current year, 0 otherwise. In Model 2 we partition FRRP
observations into two non-overlapping subsets based on the company’s stock market segment (i.e., FRRP_Main and
FRRP_AIM). See Appendix 3 for the definition of variables. All continuous variables are winsorized at the 1 st and
99th percentiles. Models 1 and 2 include year- and firm-fixed effects. In italics we report t-statistics based on firm
clusters and heteroskedasticity-corrected standard errors. ***, ** and * denote significance at the 1%, 5% and 10%
levels, respectively (two-tailed test).
42

Table 2: Additional Analysis of Audit Fee Model
Panel A: Times under FRRP
1 2
FRRP_Times 0.073*** -
2.61
FRRP_Times2 -0.013* -
-1.89
FRRP_TimesWeighted - 1.840***
3.21
FRRP_TimesWeighted2 - -3.190***
-3.10
Controls Yes Yes
N 13,249 13,249
Adjusted R2 0.90 0.90
Panel B: Dynamics
N 1 2 3 4
Last_Before 569 0.023 0.022 0.022 0.022
0.77 0.76 0.74 0.75
FRRP 1,275 0.079** - - -
2.54
FRPR_Once&Consecutive 1,157 - 0.083** - -
2.54
Between 234 0.081* 0.074 0.079* 0.080
1.77 1.60 1.67 1.61
FRRP_NonConsecutive 118 - 0.022 0.027 0.028
0.44 0.55 0.58
FRRP_FirstYear 665 - - 0.055* 0.055*
1.79 1.79
FRRP_Consecutive 492 - - 0.128*** -
2.58
FRRP_Consecutive_Y2 306 - - - 0.142***
3.12
FRRP_Consecutive_Y3 141 - - - 0.068
1.09
FRRP_Consecutive_Y4 45 - - - 0.215
1.53
First_After 369 -0.002 -0.004 -0.005 -0.005
-0.07 -0.11 -0.16 -0.17
Controls Yes Yes Yes Yes
N 13,249 13,249 13,249 13,249
Adjusted R2 0.90 0.90 0.90 0.90
This table reports the coefficient estimates from additional analyses relating to the dynamic structure of the relation
between FRRP and audit fees; and to the audit fee implications of FRRP for repeatedly targeted sectors.
In Panel A, Model 1 we employ FRRP_Times counting the number of times (years) a company’s sector has been
subject to FRRP review as well as the quadratic term of FRRP_Times; in Model 2 we weight both terms by the
number of companies in each sector-year. To illustrate the FRRP coding in Panel B, we use the example of the
Travel sector, which is under review in 2006, 2007, 2008 and 2010. In this case Last_Before takes the value of 1 in
2005; FRRP equals 1 in 2006-2008 and 2010; Between is coded 1 in 2009; First_After takes the value of 1 in 2011;
FRRP_Once&Consecutive is coded 1 in 2006-2008; FRRP_NonConsecutive equals 1 in 2010; FRRP_FirstYear
takes the value of 1 in 2006; FRRP_Consecutive equals 1 in 2007 and 2008; whereas FRRP_Consecutive_Y2 and
43

FRRP_Consecutive_Y3 are coded 1 in 2007 and 2008, respectively (see Appendix 2).
Regression analysis is based on versions of Equation (1), as follows:
The sample includes all UK domiciled companies listed on the LSE between 2000 and 2011. The dependent variable
Fees is the natural logarithm of audit fees in thousands of British Pounds. FRRP is an indicator variable equal to 1
for companies in sectors under FRRP review in the current year, 0 otherwise. See Appendix 3 for the definition of all
other variables. All continuous variables are winsorized at the 1 st and 99th percentiles. All models include year- and
firm-fixed effects. In italics we report t-statistics based on firm clusters and heteroskedasticity-corrected standard
errors. ***, ** and * denote significance at the 1%, 5% and 10% levels, respectively (two-tailed test).
44

Table 3: FRRP and Accruals
Panel A: Sample Distribution by Year
Year Total Main AIM Target Non-Target
2001 1,019 752 267 0 1,019
2002 993 695 298 0 993
2003 967 638 329 0 967
2004 932 572 360 0 932
2005 963 513 450 145 818
2006 1,015 461 554 245 770
2007 1,034 439 595 135 899
2008 965 425 540 124 841
2009 906 401 505 193 713
2010 841 377 464 137 704
2011 799 364 435 180 619
Total 10,434 5,637 4,797 1,159 9,275
45

Panel B: Sample Distribution by Industry
Non- Non-
Industry Total Main AIM Target Industry Total Main AIM Target
Target Target
Aerospace & Defense 131 117 14 0 131 Industrial 467 290 177 0 467
Engineering
Alternative Energy 55 18 37 0 55 Industrial Metals & 38 13 25 0 38
Mining
Automobiles & Parts 60 34 26 6 54 Industrial 186 131 55 16 170
Transportation
Beverages 86 58 28 0 86 Leisure Goods 92 43 49 0 92
Chemicals 199 137 62 0 199 Media 832 343 489 155 677
Construction & 388 268 120 0 388 Mining 337 123 214 0 337
Materials
Electricity 59 25 34 10 49 Mobile 74 23 51 6 68
Telecommunications
Electronic & Electrical 443 209 234 0 443 Oil & Gas Producers 353 163 190 0 353
Equip.
Fixed Line 113 71 42 12 101 Oil Equip., Services 105 55 50 0 105
Telecommunications & Distribution
Food & Drug Retailers 93 81 12 37 56 Personal Goods 195 125 70 0 195
Food Producers 255 170 85 0 255 Pharmaceuticals & 480 212 268 45 435
Biotechnology
Forestry & Paper 19 9 10 0 19 Software & 1,222 471 751 97 1,125
Computer Services
Gas, Water & Multi- 109 102 7 19 90 Support Services 1,545 790 755 294 1,251
utilities
General Industrials 151 108 43 0 151 Technology 320 193 127 0 320
Hardware & Equip.
General Retailers 585 428 157 244 341 Tobacco 27 27 0 0 27
Health Care Equip. & 316 135 181 0 316 Travel & Leisure 756 440 316 198 558
Services
Household Goods & 343 225 118 20 323 Total 10,434 5,637 4,797 1,159 9,275
Home Construction
46

Panel C: Descriptive Statistics (N=10,434)
Full Sample Post-2004
Target Target Not- Never
Diff Diff Diff
Mean Q1 Median Q3 SD Under review Under review Target
(a-b) (a-c) (b-c)
(a) (b) (c)
T_ACC 0.014 -0.053 0.020 0.096 0.248 0.014 0.029 0.035 −
TOP_ACC 0.028 -0.060 0.017 0.114 0.232 0.024 0.044 0.049 − −−
WC_ACC 0.000 -0.036 0.000 0.038 0.102 -0.003 -0.004 0.006 − −−
NCO_ACC 0.028 -0.039 0.007 0.081 0.207 0.026 0.049 0.043 −− −
FIN_ACC -0.013 -0.054 0.000 0.038 0.163 -0.010 -0.016 -0.012
TOA_ACC 0.050 -0.060 0.029 0.145 0.279 0.043 0.074 0.071 −− −
TOL_ACC 0.023 -0.027 0.015 0.071 0.127 0.022 0.029 0.023
WCA_ACC 0.017 -0.024 0.012 0.063 0.116 0.015 0.023 0.020
WCL_ACC 0.018 -0.022 0.011 0.056 0.107 0.019 0.028 0.015 ++
NCOA_ACC 0.033 -0.033 0.005 0.077 0.211 0.028 0.051 0.051 −− −
NCOL_ACC 0.005 -0.008 0.000 0.014 0.052 0.004 0.002 0.007 −
AIM 0.460 0.000 0.000 1.000 0.498 0.512 0.576 0.524 − +
IFRS 0.539 0.000 1.000 1.000 0.498 0.864 0.848 0.878 −
Size 11.178 9.581 10.984 12.591 2.250 11.569 10.974 11.253 ++
Leverage 0.118 0.000 0.051 0.190 0.153 0.143 0.125 0.094 ++ ++
Loss 0.367 0.000 0.000 1.000 0.482 0.321 0.366 0.348
BigAuditor 0.751 1.000 1.000 1.000 0.433 0.746 0.734 0.711 +
December 0.429 0.000 0.000 1.000 0.495 0.377 0.427 0.488 −
M/B 2.360 0.841 1.598 2.949 4.466 2.498 2.516 2.244
CFO 0.022 -0.016 0.065 0.129 0.224 0.051 0.014 0.020 + ++
SalesGrowth 0.280 -0.044 0.072 0.242 1.086 0.180 0.309 0.329 −− −−
PPEGrowth 0.161 -0.122 0.002 0.170 0.848 0.162 0.206 0.215
CFOVolatility 0.300 0.028 0.059 0.128 1.267 0.203 0.210 0.162 +
PD 0.005 0.001 0.002 0.005 0.016 0.007 0.006 0.005 ++
IndAC (proportional) 0.701 0.000 1.000 1.000 0.458 0.707 0.675 0.705
IndAC (complete) 0.526 0.000 1.000 1.000 0.499 0.567 0.537 0.547
47

Panel D: Regression of Accruals Model by Category of Accruals
T_ACC TOP_ACC WC_ACC NCO_ACC FIN_ACC
1 2 3 4 5 6 7 8 9 10
FRRP -0.007 - -0.007 - -0.001 - -0.007 - 0.001 -
-0.88 -1.04 -0.23 -1.22 0.19
FRRP_Main - -0.013 - -0.021*** - -0.007* - -0.016** - 0.008
-1.61 -3.07 -1.95 -2.32 1.14
FRRP_AIM - -0.001 - 0.007 - 0.005 - 0.000 - -0.006
-0.06 0.69 0.90 0.01 -0.63
AIM 0.040*** 0.040*** 0.045*** 0.042*** 0.000 -0.001 0.043*** 0.041*** -0.007 -0.006
2.96 2.87 3.41 3.22 0.03 -0.15 3.58 3.44 -0.67 -0.58
IFRS -0.017 -0.016 -0.003 -0.001 -0.012** -0.011** 0.009 0.011 -0.014* -0.015**
-1.56 -1.47 -0.32 -0.09 -2.52 -2.32 1.04 1.17 -1.89 -2.05
Size 0.054*** 0.054*** 0.075*** 0.075*** 0.012*** 0.012*** 0.062*** 0.062*** -0.020*** -0.020***
5.87 5.87 10.28 10.27 3.42 3.41 9.76 9.76 -3.35 -3.35
Leverage -0.189*** -0.188*** 0.120*** 0.121*** 0.041** 0.042** 0.066** 0.066** -0.333*** -0.333***
-4.16 -4.16 3.16 3.18 2.39 2.41 2.06 2.08 -9.44 -9.46
Loss -0.167*** -0.167*** -0.148*** -0.148*** -0.063*** -0.063*** -0.078*** -0.078*** -0.019*** -0.019***
-21.16 -21.15 -20.95 -20.93 -16.44 -16.45 -12.54 -12.52 -3.66 -3.67
BigAuditor -0.020 -0.020 -0.017 -0.017 -0.006 -0.006 -0.010 -0.010 -0.009 -0.009
-1.06 -1.06 -1.09 -1.09 -1.08 -1.08 -0.66 -0.65 -0.81 -0.82
December 0.003 0.003 -0.006 -0.007 -0.001 -0.002 -0.005 -0.005 0.007 0.007
0.13 0.11 -0.27 -0.32 -0.12 -0.15 -0.26 -0.29 0.39 0.42
M/B 0.004*** 0.004*** 0.002*** 0.002*** 0.000 0.000 0.002*** 0.002*** 0.002** 0.002**
3.71 3.71 2.63 2.64 0.15 0.15 3.35 3.35 2.37 2.36
CFO -0.235*** -0.235*** -0.349*** -0.350*** -0.252*** -0.252*** -0.064*** -0.065*** 0.090*** 0.090***
-7.22 -7.23 -13.98 -14.03 -15.34 -15.38 -2.80 -2.82 4.10 4.12
SalesGrowth 0.021*** 0.021*** 0.024*** 0.024*** 0.003* 0.003* 0.021*** 0.022*** -0.005* -0.005*
4.55 4.56 6.39 6.42 1.80 1.83 5.97 5.99 -1.82 -1.84
PPEGrowth 0.068*** 0.068*** 0.096*** 0.095*** -0.003 -0.003 0.098*** 0.098*** -0.030*** -0.030***
13.81 13.81 20.45 20.45 -1.61 -1.62 21.22 21.21 -8.30 -8.29
CFOVolatility 0.003 0.003 0.002 0.002 0.000 0.000 0.002 0.002 0.001 0.001
1.51 1.50 1.11 1.09 0.02 0.00 1.31 1.29 0.83 0.85
Intercept -0.533*** -0.532*** -0.787*** -0.786*** -0.107*** -0.107*** -0.661*** -0.660*** 0.254*** 0.253***
-5.17 -5.17 -9.57 -9.56 -2.86 -2.84 -9.26 -9.24 3.87 3.86
48

N 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434
Adjusted R2 0.22 0.22 0.34 0.34 0.12 0.12 0.34 0.34 0.08 0.08
This table presents the accruals sample distribution by year (Panel A) and by industry sector based on the three-digit ICB code (Panel B). In both panels we
decompose the sample into Main and AIM as well as into targeted and non-targeted firm-years. Panel C reports the distributional properties of all variables used
in the accruals analysis for the entire sample as well as separately for the subsamples comprising of targeted under review, targeted not under review, and never-
targeted observations in the post-2004 period; we note that the number of firm-years in the case of PD and IndAC is 9,435 and 9,393 respectively due to
additional missing observations. Tests of significance are based on regression of each variable on FRRP and year fixed effects, where standard errors are clustered
at the sector-year level (based on three-digit ICB codes). ++ (− −), and + (−) denote significance at the 1% and 5% levels, respectively (two-tailed test).
Panel D reports the coefficient estimates based on versions of Equation (2), as follows:
Accruals = 0 + 1FRRP + ∑12 𝑗=1 𝛿𝑗 Firm-Specific Controls + FFE + YFE + v (2)
The sample includes all UK domiciled companies listed on the LSE between 2001 and 2011. The dependent variables T_ACC, TOP_ACC, WC_ACC, NCO_ACC
and FIN_ACC stand for total accruals, total operating accruals, current operating accruals, non-current operating accruals and financial accruals, respectively.
FRRP is an indicator variable equal to 1 for companies in sectors under FRRP review in the current year, 0 otherwise. In Models 2, 4, 6, 8, and 10 we partition
FRRP observations into two non-overlapping subsets based on the company’s stock market segment (i.e., FRRP_Main and FRRP_AIM). See Appendix 3 for the
definition of variables. All continuous variables are winsorized at the 1 st and 99th percentiles. All models include year- and firm-fixed effects. In italics we report
t-statistics based on firm clusters and heteroskedasticity-corrected standard errors. ***, ** and * denote significance at the 1%, 5% and 10% levels, respectively
(two-tailed test).
49

Table 4: Additional Analysis of Accruals Model by Further Decomposition
TOA_ACC TOL_ACC WCA_ACC WCL_ACC NCOA_ACC NCOL_ACC
1 2 3 4 5 6 7 8 9 10 11 12
FRRP -0.013* - -0.002 - -0.004 - -0.003 - -0.008 - 0.001 -
-1.74 -0.53 -1.14 -0.86 -1.36 0.57
FRRP_Main - -0.023*** - 0.000 - -0.008** - -0.001 - -0.013** - 0.001
-2.89 0.01 -2.01 -0.38 -2.12 0.38
FRRP_AIM - -0.003 - -0.004 - -0.000 - -0.005 - -0.003 - 0.001
-0.28 -0.61 -0.01 -0.77 -0.31 0.43
Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434 10,434
Adjusted R2 0.42 0.42 0.15 0.15 0.23 0.23 0.15 0.15 0.38 0.38 -0.02 -0.02
This table reports the coefficient estimates from additional analyses after decomposing further accruals into their assets and liabilities components based on
versions of Equation (2), as follows:
Accruals = 0 + 1FRRP + ∑12 𝑗=1 𝛿𝑗 Firm-Specific Controls + FFE + YFE + v (2)
The sample includes all UK domiciled companies listed on the LSE between 2001 and 2011. The dependent variables TOA_ACC, TOL_ACC, WCA_ACC,
WCL_ACC, NCOA_ACC and NCOL_ACC stand for total operating assets accruals, total operating liabilities accruals, current operating assets accruals, current
operating liabilities accruals, non-current operating assets accruals and non-current operating liabilities accruals, respectively. FRRP is an indicator variable equal
to 1 for companies in sectors under FRRP review in the current year, 0 otherwise. In Models 2, 4, 6, 8, 10, and 12 we partition FRRP observations into two non-
overlapping subsets based on the company’s stock market segment (i.e., FRRP_Main and FRRP_AIM). See Appendix 3 for the definition of variables. All
continuous variables are winsorized at the 1 st and 99th percentiles. All models include year- and firm-fixed effects. In italics we report t-statistics based on firm
clusters and heteroskedasticity-corrected standard errors. ***, ** and * denote significance at the 1%, 5% and 10% levels, respectively (two-tailed test).
50

Table 5: Further Cross-Sectional Analysis
Panel A: Probability of Default
Fees TOP_ACC WC_ACC NCO_ACC
N
1 2 3 4
FRRP_Main_HighPD 244 0.075 -0.004 -0.007 0.003
(243) 1.09 -0.36 -1.31 0.33
FRRP_Main_LowPD 301 0.020 -0.032*** -0.005 -0.026***
(292) 0.54 -4.06 -1.23 -3.52
FRRP_AIM_HighPD 355 0.110*** 0.026* 0.005 0.017
(337) 2.99 1.75 0.68 1.29
FRRP_AIM_LowPD 220 0.049 -0.010 0.010 -0.019
(199) 1.00 -0.79 1.56 -1.59
HighPD 0.041** -0.002 -0.002 0.000
2.35 -0.33 -0.78 -0.07
AIM -0.097** 0.051*** 0.002 0.046***
-2.39 3.37 0.33 3.49
AIM_HighPD -0.039 -0.007 -0.008 0.002
-1.52 -0.68 -1.48 0.19
Controls Yes Yes Yes Yes
N 11,373 9,435 9,435 9,435
Adjusted R2 0.90 0.34 0.13 0.34
51

Panel B: Audit Committee Independence
>50% Independent AC 100% Independent AC
Fees TOP_ACC WC_ACC NCO_ACC Fees TOP_ACC WC_ACC NCO_ACC
N N
1 2 3 4 5 6 7 8
FRRP_Main_IndAC 547 0.052 -0.021*** -0.008** -0.013* 460 0.075 -0.022*** -0.008** -0.013*
(528) 1.16 -2.86 -2.15 -1.92 (444) 1.45 -2.94 -2.26 -1.95
FRRP_Main_NonIndAC 32 -0.087 -0.006 0.012 -0.043 119 -0.073 -0.011 0.001 -0.020
(31) -1.04 -0.12 0.77 -1.42 (115) -1.44 -0.61 0.11 -1.27
FRRP_AIM_IndAC 271 0.076* -0.006 0.000 -0.008 191 0.043 -0.000 0.002 -0.004
(245) 1.86 -0.44 0.06 -0.60 (176) 0.83 -0.03 0.24 -0.25
FRRP_AIM_NonIndAC 331 0.089* 0.012 0.008 0.000 411 0.098** 0.007 0.006 -0.002
(289) 1.83 0.79 0.94 0.03 (358) 2.42 0.52 0.84 -0.17
IndAC 0.017 -0.012 0.004 -0.012 -0.025 0.005 -0.000 0.006
0.48 -0.99 0.86 -1.20 -1.07 0.72 -0.13 1.04
AIM -0.089 0.041** 0.000 0.040** -0.106** 0.048*** -0.002 0.046***
-1.56 2.13 0.02 2.32 -2.12 2.83 -0.32 3.07
AIM_IndAC -0.045 0.016 0.003 0.013 -0.031 0.010 0.008 0.008
-0.83 0.88 0.33 0.83 -0.63 0.59 1.11 0.59
Controls Yes Yes Yes Yes Yes Yes Yes Yes
N 11,352 9,393 9,393 9,393 11,352 9,393 9,393 9,393
Adjusted R2 0.90 0.35 0.12 0.35 0.90 0.35 0.12 0.35
This table reports the coefficient estimates from further cross-sectional tests based on versions of Equations (1) and (2), as follows:
12
Accruals = 0 + 1FRRP + ∑𝑗=1 𝛿𝑗 Firm-Specific Controls + FFE + YFE + v (2)
The sample includes all UK domiciled companies listed on the LSE between 2000 and 2011. In Panel A, we examine the audit fees (Model 1) and accruals
(Models 2-4) FRRP effects separately for Main and AIM companies conditioning on their probability of default (PD). We transform the continuous variable of
PD into a binary indicator by using the sample median as the classification cut-off; and we employ this indicator to distinguish targeted Main and AIM
companies between high and low probability of default (i.e., HighPD and LowPD respectively). In Panel B, we examine the audit fees (Models 1 and 5) and
accruals (Models 2-4 and Models 6-8) FRRP effects separately for Main and AIM companies conditioning on audit committee independence (i.e., IndAC and
NonIndAC), defined as more than 50% membership (i.e., proportional independence) and 100% membership (i.e., complete independence). The dependent
variable Fees is the natural logarithm of audit fees in thousands of British Pounds whereas the dependent variables TOP_ACC, WC_ACC, and NCO_ACC stand
for total operating accruals, current operating accruals and non-current operating accruals, respectively. FRRP is an indicator variable equal to 1 for companies in
sectors under FRRP review in the current year, 0 otherwise. See Appendix 3 for the definition of variables. In both Panels we report the number of observations
for the audit fees model (accruals models) in each FRRP sub-group. All continuous variables are winsorized at the 1 st and 99th percentiles. All models include
year- and firm-fixed effects. In italics we report t-statistics based on firm clusters and heteroskedasticity-corrected standard errors. ***, ** and * denote
significance at the 1%, 5% and 10% levels, respectively (two-tailed test).
52

Table 6: Sensitivity Analysis
Panel A: Audit Fees
Target Only Full Sample Industry Fixed Efffects
1 2 3 4 5 6
FRRP 0.051** - 0.050** - 0.100*** -
2.19 2.14 3.39
FRRP_Main - 0.024 - 0.029 - 0.071
0.60 0.70 1.38
FRRP_AIM - 0.073** - 0.067** - 0.122***
2.42 2.23 2.70
FRRP_Never - - -0.087*** - - -
-2.90
FRRP_Never_Main - - - -0.102*** - -
-2.80
FRRP_Never_AIM - - - -0.073** - -
-2.01
Controls Yes Yes Yes Yes Yes Yes
N 7,640 7,640 13,249 13,249 13,249 13,249
Adjusted R2 0.88 0.88 0.90 0.90 0.83 0.83
Panel B1: Total Operating Accruals, Current and Non-Current Operating Accruals
TOP_ACC WC_ACC NCO_ACC
Target only Full Sample Target only Full Sample Target only Full Sample
1 2 3 4 5 6 7 8 9 10 11 12
FRRP -0.006 - -0.006 - 0.000 - 0.001 - -0.007 - -0.009 -
-0.87 -0.99 0.05 0.20 -1.17 -1.34
FRRP_Main - -0.020*** - -0.021*** - -0.005 - -0.005 - -0.017** - -0.016**
-2.82 -2.88 -1.33 -1.38 -2.33 -2.31
FRRP_AIM - 0.008 - 0.007 - 0.005 - 0.006 - 0.001 - -0.001
0.79 0.64 0.89 1.10 0.11 -0.13
FRRP_Never - - 0.001 - - - 0.008** - - - -0.006 -
0.09 2.15 -0.69
FRRP_Never_ - - 0.006 - - - 0.008** - - - 0.001
Main 0.58 2.07 0.10
FRRP_Never_ - - - -0.009 - - - 0.008 - - - -0.018
AIM -0.51 1.18 -1.23
53

Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 6,257 6,257 10,434 10,434 6,257 6,257 10,434 10,434 6,257 6,257 10,434 10,434
Adjusted R2 0.34 0.34 0.34 0.34 0.08 0.08 0.12 0.12 0.34 0.34 0.34 0.34
Panel B2: Total Operating Accruals, Current and Non-Current Operating Accruals
TOP_ACC WC_ACC NCO_ACC
Industry Fixed Effects Industry Fixed Effects Industry Fixed Effects
1 2 3 4 5 6
FRRP -0.009* - 0.001 - -0.013** -
-1.73 0.22 -2.05
FRRP_Main - -0.024*** - -0.004 - -0.022***
-3.50 -1.09 -2.76
FRRP_Aim - 0.003 - 0.004 - -0.004
0.51 0.78 -0.61
Controls Yes Yes Yes Yes Yes Yes
N 10,434 10,434 10,434 10,434 10,434 10,434
Adjusted R2 0.29 0.29 0.10 0.10 0.30 0.30
This table reports the coefficient estimates from a series of robustness tests based on versions of Equations (1) and (2), as follows:
Fees = α0 + α1 FRRP + ∑19 𝑗=1 𝛾𝑗 Firm-Specific Controls + FFE + YFE + ε (1)
12
Accruals = 0 + 1FRRP + ∑𝑗=1 𝛿𝑗 Firm-Specific Controls + FFE + YFE + v (2)
The sample includes all UK domiciled companies listed on the LSE between 2000 and 2011. In Panel A the dependent variable Fees is the natural logarithm of
audit fees in thousands of British Pounds. In Models 1 and 2 we exclude the never-targeted firm-years from the control group. In Model 3 (Model 4) we explicitly
examine the audit fee effects of FRRP for all companies (for Main and AIM companies) in the never-targeted sectors by including the FRRP_Never variable
(FRRP_Never_Main and FRRP_Never_AIM variables, respectively). In Models 5 and 6 we employ the full sample and replace firm-fixed effects with industry
fixed effects (based on the four-digit ICB code). In Panels B1 and B2 the dependent variables TOP_ACC, WC_ACC, and NCO_ACC stand for total operating
accruals, current operating accruals and non-current operating accruals, respectively. In Panel B, Models 1, 2, 5, 6, 9 and 10 we exclude the never-targeted firm-
years from the control group. In Models 3, 7 and 11 (Models 4, 8 and 12) we explicitly examine the accruals effects of FRRP for all companies (for Main and
AIM companies) in the never-targeted sectors by including the FRRP_Never variable (FRRP_Never_Main and FRRP_Never_AIM variables respectively). In
Panel B2, Models 1-6 we employ the full sample and replace firm-fixed effects with industry fixed effects (based on the four-digit ICB code). FRRP is an
indicator variable equal to 1 for companies in sectors under FRRP review in the current year, 0 otherwise. See Appendix 3 for the definition of variables. All
continuous variables are winsorized at the 1 st and 99th percentiles. All models include year- and firm-fixed effects. In italics we report t-statistics based on firm
clusters and heteroskedasticity-corrected standard errors. ***, ** and * denote significance at the 1%, 5% and 10% levels, respectively (two-tailed test).
54

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Proactive Financial Reporting Enforcement:

Audit Fees and Financial Reporting Quality Effects

Electronic copy available at: https://ssrn.com/abstract=2878891

JEL Classifications: K42, M41, M42, M48

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quality, using accruals and their components.

represents a “clean” change in enforcement procedures resulting in increases in enforcement

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change or a reduction in the level of scrutiny of their financial statements. Consequently, we

financial reporting enforcement on compliance costs and financial reporting quality.

determinants. The increase in audit fees is transitory, dependent on cumulative enforcement

other standard accruals determinants.

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costs, when compared to companies in non-targeted sectors.

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committees) respond to increased enforcement through more conservative accruals. Similarly,

services according to risk-related client factors (Causholli and Knechel 2012).

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other relevant contemporaneous regulatory changes either affect all UK companies

in our research design.1

complements these studies by exploiting a cleaner setting of changes in financial reporting

quality and compliance costs; and by documenting cross-sectional variation in enforcement

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scrutiny focuses on financial reporting outcomes, we contribute relevant evidence on regulatory

report our sensitivity tests, and we conclude in Section VI.

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approach involves a program of review of financial statements based on risk assessment. In

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in sector selection in our empirical analysis.

common sanction is to require financial statements to be restated (including amendments to

releases identifying financial reporting deficiencies in Appendix 1 should not necessarily be

interpreted as evidence of high quality financial reporting, or as evidence of ineffective

preparers and auditors resulting in higher quality, compliant financial statements.

Prior Literature and Hypotheses

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experience, hence incurring higher audit costs.7

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auditor (DeFond and Zhang 2014).

second hypotheses as follows:

Cross-Sectional Variation in Enforcement Effects

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Audit costs effects

specific sources of engagement risk.

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While we expect market segment to capture differences in the components of engagement

to auditor business risk differences within the two market segments.12

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A company’s pre-audited financial reporting quality is a function of (i) innate characteristics

enforcement regime, greater enforcement mitigates managers’ incentives for earnings

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independence within market segment, to capture differential enforcement effects on financial

III. RESEARCH DESIGN

FRRP Proactive Review Treatment Variable

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risk-based monitoring method.

Fees = α0 + α1 FRRP + ∑19

including Size, BusSegments, GeoSegments, ForeignSales, InvReceiv, Impairments, Acquisition,

Qualified, ROA, Loss, Quick, Leverage, December, BigAuditor, NegativeEquity, M/B,

detail the construction of all variables used in the study.

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Accruals = 0+ 1FRRP + ∑12

To strengthen identification in estimating Equation (2) we examine a number of accruals

http://www.londonstockexchange.com/statistics/companies-and-issuers/companies-and-issuers.htm). Since this data