Are Financial Statement Audits Too Coarse? Evidence from Audits of Technology Service Companies

Abstract

A modern firm has many types of stakeholders, each of whom typically interacts with a different part of the firm's business model. Theory predicts that while some stakeholders may benefit from financial statement audits, these audits may be too coarse for other stakeholders. As a result, there may be demand for supplemental audits of other parts of the firm ("non-financial audits"). This study provides some of the first systematic evidence on such audits in the setting of corporations that process financial data at technology services companies such as cloud computing providers. Using hand-collected data from public companies, I find that the large audit firms are often hired to issue a special class of audit reports meant for the corporate customers of technology services companies. A company's business-model exposure to providing technology services is predictive of its decision to receive these audits, and the scope of these audits includes customer-relevant internal controls over data security and processing integrity. These audits are also associated with a large increase in audit-related fees that is highly economically significant when compared to the fees for other corporate accounting services. These findings highlight the economic significance of non-financial audits in our attempts to understand the audit fee environment.