Mandatory CSR and its impact on audit fees

Abstract

Purpose This paper aims to examine the effect of compliance to mandatory corporate social responsibility (CSR) on audit fees in the Indian setting. Design/methodology/approach The sample consists of 1,291 Indian-listed firms that were mandated by Clause 135 of the Companies Act 2013 to spend 2% of their average three-year profits before tax as CSR expenditure. The period of the study is from 2015 to 2019. The authors use a fixed-effect regression model. In addition, the authors also use the Heckman Selection Model, controlling for potential self-selection, a difference-in-differences and the regression discontinuity design analysis. Findings The authors find that firms complying with mandatory CSR regulation had to incur high audit fees, and the effect is more pronounced for firms that did not have CSR activities before the mandatory CSR regulation. In addition, the authors also find that audit fees are higher for firms with higher levels of operating, business and financial reporting risks. Thus, the result supports the notion that auditors associate higher inherent risk with audit risk for firms that are forced to engage in CSR activities. Practical implications The findings are potentially informative to regulators and policymakers in India and in other jurisdictions that may be considering mandating CSR. Originality/value To the best of the authors’ knowledge, this is the first work that looks at how auditors react to the firm’s compliance with mandatory CSR policies. The authors show that for an auditor, CSR compliance is an aspect of audit risk and it has not been explored in the extant literature, as a regulatory intervention in the form of mandatory CSR spending is unique (first of its kind) in the Indian setting. Prior work focuses on CSR disclosure; however, the setup allows us to examine CSR spending mandated by regulation. Moreover, the authors also add to the literature on audit fee determinants.