Pricing Efficiency of Audit Fees Given Audit Risk: 1)Comparison between Pre- and Post-New ISA Periods in the Korean Audit Market

This study aims to determine if the risk-based auditing approach (New International Standard on Auditing: New ISA) helps make the auditing market more efficient. Since a strong positive relationship between risk and reward implies that contracts are concluded efficiently in the audit market, an enhancement in pricing efficiency likely leads to an improvement in audit quality. For this reason, this study compares the pricing efficiency between audit risk and audit fees in time series to verify the effect of introducing the New ISA. We use accruals quality (Francis et al. 2004, 2005) as a proxy for audit risk and compare the sensitivity of audit fees to audit risk between the pre- and post-New ISA periods. Our findings are as follows: (ⅰ) The sensitivity of audit fees to audit risks significantly increased after the introduction of the New ISA, and these results suggest that pricing efficiency has improved in the audit market. (ii) Audit quality (proxy: earnings management) increases on average after the introduction of the New ISA, and the improvement in audit quality is particularly noticeable in samples with high risk-reward sensitivity. This suggests that the effectiveness of risk-based auditing has a complementary relationship with the pricing efficiency of audit fees. Overall, our results suggest that the effectiveness of the risk-based audit system can be optimized through the implementation of an efficient pricing system that aligns audit fees with risk in the audit market.