The Pricing of Audit Services, Board Composition and Corporate Control: International Evidence from the Life Insurance Industry

We investigate the relationship of audit fees, outside directors and firms’ ownership, marketing and asset structures as alternative (external versus internal) monitoring mechanisms that can be used to control incentive conflicts in costly contracting environments, by exploiting variation in ownership within the Australian and UK life insurance industries. In mutuals, ownership rights are not transferable. This inalienability restricts the effectiveness of control mechanisms like external take-overs, thus increasing the importance of audit fees and monitoring by outside directors, while reducing the strength of association between internal control mechanisms, performance and board structure. We further posit that the predicted strength and direction of these relationships between external and internal monitoring mechanisms is conditioned by corporate governance rules. Finally we predict that higher audit fees and board composition are associated with firms facing changes in their corporate control. We examine these predictions for samples of 25 Australian and 36 UK firms in 1991 and 1995. While firms operating in these countries faced similar operating conditions during this period, more stringent solvency rules were imposed in Australia and new corporate governance standards were developed in the UK. Our hypothesis tests thus control for the effects of regulatory change in these countries. Our results are consistent with these predictions only for UK firms. We conclude that the strength of association between audit fees, corporate control and board composition is conditioned by regulatory effectiveness.