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A test of the free cash flow and debt monitoring hypotheses: evidence from audit pricing
journal contributionposted on 1997-12-01, 00:00 authored by Ferdinand Gul, J S L Tsui
This study examines the association between free cash flow (FCF) and audit fees. The association is expected given Jensen’s argument that managers of low growth/high FCF firms engage in non-value-maximizing activities. These activities increase auditors’ assessments of inherent risk and, in turn, audit effort and fees. Jensen also argues debt mitigates the non-value-maximizing activities. Thus, the positive FCF/audit fees association is expected to be weaker for low growth firms with high debt than for similar firms with low debt. Regression results for a sample of low growth Hong Kong firms support these hypotheses.