A TEST OF THE FREE CASH FLOW AND DEBT MONITORING HYPOTHESES - EVIDENCE FROM AUDIT PRICING

This study examines the association between free cash flow (FCF) and a udit fees. The association is expected given Jensen's argument that ma nagers of low growth/high FCF firms engage in non-value-maximizing act ivities. These activities increase auditors' assessments of inherent r isk and, in turn, audit effort and fees. Jensen also argues debt mitig ates the non-value-maximizing activities. Thus, the positive FCF/audit fees association is expected to be weaker for low growth firms with h igh debt than for similar firms with low debt. Regression results for a sample of low growth Hong Kong firms support these hypotheses. (C) 1 998 Elsevier Science B.V. All rights reserved.