Intellectual capital disclosure, audit risk, and audit fees: evidence from the UK and Italy

Disclosure theory argues that high-quality information reduces audit risk as it decreases information asymmetry in the market and, consequently, information risk for companies. These findings prompted some authors to investigate the association between company reputation risk and audit risk. Although several academics examined what determines audit risk, there is little empirical evidence on the actual effects of audit risk due to the intellectual capital disclosures (ICD). Prior studies report only that CFOs perceive intellectual capital as a tool for promoting a reputation for transparency and for reducing information risk. Extant literature on voluntary disclosure analyzes the relationships between corporate social responsibility (CSR) and audit risk, finding that auditors charge lower fees and issue less going concern opinions to companies with good CSR performance. Specifically, authors argue that auditors use CSR disclosure in assessing a client’s audit risk. Despite these considerations, little is known about how audit partners really assess audit risk, and many scholars, therefore, use public audit fees as a proxy for audit risk. In this study, we test the relationship between intellectual capital disclosure and audit risk (AR). The AR is measured from both a qualitative and quantitative perspective. Empirical findings from a sample of 191 UK and Italian listed companies for the period 2004-2011 show that auditors estimate a lower qualitative risk, albeit a higher quantitative one, for companies reporting higher ICD scores, compared to those with lower disclosure scores on the IC. Furthermore, we find that reputation risk significantly contributes to the relationship between intellectual capital disclosure and AR. Finally, we assess the effect of ICD and AR on audit fees. Country comparison between the UK and Italian companies also provides fruitful insights for future research avenues.