Auditor compensation, disclosure quality, and market liquidity: Evidence from the stock market

Previous studies on the effects of auditor compensation on disclosure quality have focused on accounting measures, such as earnings management, discretionary accruals, and restatements. In contrast, we investigate the impact of fees paid for audit and non-audit services on a market-based measure of disclosure quality and stock market liquidity. Based on a large sample of NYSE-traded S&P 1500 stocks, we find only weak evidence to support the argument that auditor compensation lowers firm disclosure quality and market liquidity. This finding is robust to alternative measures of bid-ask spreads and asymmetric information costs of trading. In addition, we find some evidence to suggest that the adverse effects of auditor compensation on market liquidity are concentrated in firms with weak corporate governance mechanisms. Our results underscore the need to revisit the rationale and scope of restrictions on non-audit services imposed recently by the Sarbanes-Oxley Act.