Financial versus operating liability leverage and audit fees

We argue that different types of leverage have different implications for audit risk and audit fees, and hence need to be separately examined. Using data from the years 2004 to 2016, we find that operating liability leverage is positively associated with audit fees and that financing leverage is negatively related to audit fees. The results suggest that the benefits from monitoring effects of financial leverage outweigh the costs associated with the risk of financial distress and financial misreporting. We also find that estimated operating liability leverage has a bigger effect on audit fees than contractual operating liability leverage, consistent with suggestions that auditors are more conservative in the presence of higher estimation risk. Thus, our findings highlight the importance of recognizing sources of leverage in audit risk in general and audit fee models in particular.