Rent-Extraction in Audit: Evidence from Hurricanes

We find that auditors charge higher audit fees to clients that over-estimate their business risk due to cognitive biases. Specifically, we focus on a group of treatment firms located in the neighborhood of a disaster area induced by a hurricane. We build on the result that those firms experience a subjective increase in their business that do not correspond to a change in their underlying risk. Using a difference-in-differences research design, we find that those firms are charged higher audit fees relative to other remote firms in the two years following the incidence of a hurricane. This is consistent with auditors extracting a rent at the expense of their clients exhibiting cognitive biases. Importantly, we further document that the ability to extract a rent is stronger for auditors with a longer tenure with their clients and weaker when there is stronger competition in the audit market.