A New Supply Risk Element to Monitor: Elevated Audit Fees

Sometimes when a supplier spends too much on audit, it's not just because they don't know how to benchmark or source the category effectively (or leverage a third-party category export like an ICG Commerce who knows the area inside and out). No, elevated audit fees can be a symptom of something much more nefarious than a lack of procurement influence on the area, if the findings from a fascinating new study are to be believed.

In the above-linked Reuters dispatch, Ryan Wilson of the Tippie College of Business at the University of Iowa suggests that, "the auditors have private information about the firm because of their interaction with management. They obviously have a lot of risk associated with any fraud at a firm, and we assume they adjust their fee accordingly." When it comes to a "high or rising fee" itself, the article suggests two possibilities: "Either the auditor is charging a risk premium, aiming to cover future legal costs to them of something going awry, or they may just be doing more work on the audit, digging into areas where results are uncertain."

Reuters quotes another study that suggests "audit fees substantially above those paid by competitors and companies of similar size are strongly associated with a slip in operating performance the following year, and to a lesser degree as many as five years later." The American Accounting Association recently published this research, by Jonathan Stanley, an accounting professor at Auburn University. Moreover, "In addition to forecasting operating declines, high audit fees are predictive of fraud and restatements, and rising fees can foreshadow steep stock price drops, credit rating downgrades and class action lawsuits," Stanley's research suggests.

Of course from a supply risk perspective, this analysis is further proof that companies should not just track the D&B or equivalent risk or credit indicators in their supply base (not performance indicators of potential supply risk including on-time performance, escapes/PPM, SLA deviation, etc.). In addition, how much a company spends with their auditors as well as the trending of this number may also be a useful indicator of broader supply risk that might be lurking underneath the sourcing surface.

-Jason Busch

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