The Effect of Alleged Financial Statement Fraud on Audit Fees and Short Interest

We investigate whether audit fees are higher for firms that allegedly committed fraud and for firms with ongoing FSF challenges and high short interest. We find a positive association between audit fees and FSF disclosures, and this association increases with the level of short interest. The results suggest that auditors either increase their efforts in searching for further FSF from firms with previous FSF incidents or increase their risk premium for firms with a high fraud risk. Auditors also consider ongoing FSF challenges reflected in the level of short interest when determining their audit fees. We find, however, that short sellers do not consider increased audit fees associated with the public disclosure of alleged FSF. Short sellers do not appear to contemplate audit risk in analyzing the business risk of alleged FSF. Our study has policy, practical, and educational implications for auditors, short sellers, and forensic accountants who investigate FSF.