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Is There a Relation Between Residual Audit Fees and Analysts’ Forecasts?

We examine the relationship between residual audit fees and the ability to predict future earnings. Recent research suggests that residual audit fees contain information about accounting quality. However, residual audit fees could either represent high accounting quality or a risk premium for low accounting quality. We extend this literature by providing evidence that residual audit fees are indicative of a lower quality information environment which has a negative impact on investors’ ability to anticipate future earnings. Specifically, we first show that residual audit fees are negatively associated with the ability of current earnings to predict future earnings. Furthermore, residual audit fees are negatively associated with analyst forecast accuracy and positively associated with the dispersion in analyst forecasts. Overall, our results are consistent with the notion that residual audit fees are indicative of poor earnings quality, and that this lower quality manifests itself in a lower quality information environment for investors and analysts.