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  • Jennifer M Mueller-Phillips
    Audit Market Concentration, Audit Fees, and Audit Quality:...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 11.0 Audit Quality and Quality Control 
    Title:
    Audit Market Concentration, Audit Fees, and Audit Quality: Evidence from China
    Practical Implications:

    This study is important given the continued concerns expressed by global regulators about the potential harm to audit quality caused by concentrated audit markets. The separation of offsetting direct and indirect effects of concentration on audit quality enhances the understanding of how concentration influences audit quality and could explain why the previous studies document mixed evidences. The study also provides evidence on how audit fees play an important role in the association between concentration and audit quality and that regulatory interventions changing one of the offsetting effects could produce potential unintended consequences. 

    Citation:

    Huang, T., Chang, H., and Chiou, J. 2016. Audit Market Concentration, Audit Fees, and Audit Quality: Evidence from China. Auditing: A Journal of Practice and Theory 35 (2): 121-145.

    Keywords:
    audit market concentration, audit fees, audit quality, and China
    Purpose of the Study:

    The potential effects of recent audit market concentration on audit fees and audit quality have been a point of concern for policy makers. The primary concern is that this concentration reduces clients’ choice of audit service suppliers, strengthens auditor’s market power, and encourages complacency among auditors, resulting in higher audit fees but lower audit quality. Despite the concern, the extant literature provides mixed evidence on the consequences of audit market concentration. The situation between developed countries where audit markets are dominated by the Big 4 audit firms, and the Chinese Ministry of Finance (MOF) is starkly different. As a result, the MOF has expressed concern about the competitive and immature Chinese audit market characterized by many small-seized audit firms, which increases auditors; incentives to compete for clients by providing fee discounts, resulting in low audit quality. The difference in attitudes toward concentration between the developed countries and China as well as the fact that China is a setting where competition is thriving, while most of the developed countries are more concerned about lack of competition is the primary motivation behind the authors examination of the Chinese audit market. The objective of the paper is to investigate the effect of concentration on audit quality in a setting with significant competition a relatively weak legal environment. 

    Design/Method/ Approach:

    The authors employ path analysis to further examine the indirect effects of concentration on audit quality through audit fees. The sample consists of 12,334 Chinese firm-year observations from 2001-2011. Audit market concentration is measured at the city level as the market shares of the local top 4 audit firms and two Herfindahl indexes of audit fees earned from listed clients of the local top 4 and all audit firms in a city-year grouping, respectively.

    Findings:
    • The authors’ findings support the claim that concentration influences audit fees; furthermore, the positive effects of concentration on audit fees is consistent with clients having a limited choice of audit service suppliers and audit firms having greater market power in concentrated audit markets. The increased market power reduces auditors’ fear of client loss and allows them to charge higher fees.
    • The authors’ findings suggest that audit market concentration has no significant overall effect on client earnings quality.
    • The authors’ findings support the notion that concentration results in poor audit quality through auditor overconfidence and complacency.
    • The authors find that concentration increases audit fees and such increases in turn improve earnings quality, suggesting that when the audit market becomes more concentrated, auditors with increased market power become less lenient with clients and charge higher fees to devote more resources and effort to audit tasks, leading to higher audit quality.
    • The authors’ findings suggest that auditors are less likely to issue modified audit opinions when the market becomes more concentrated.
    • The authors find that in concentrated audit markets auditors have greater market power and lower cost of tell the truth and can charge higher audit fees to devote more resources and efforts to the audits that they carry out.
    Category:
    Audit Quality & Quality Control, Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions
  • Jennifer M Mueller-Phillips
    Audit Market Structure and Audit Pricing
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions 
    Title:
    Audit Market Structure and Audit Pricing
    Practical Implications:

    The results of this paper contribute to the understanding of the determinants of audit firms’ initial audit price discount decisions. The results suggest that concentration of audit firms within the local audit market has a stronger influence on non-Big 4 audit firms’ initial pricing decisions compared to Big 4 firms’ initial pricing decisions. In addition, the results are of interest to regulators and managers who are concerned about the effect of audit market concentration on audit pricing and audit quality.

    Citation:

    Eshleman, J. D. and B. P. Lawson. 2017. Audit Market Structure and Audit Pricing. Accounting Horizons 31 (1): 57 – 81. 

    Keywords:
    audit pricing, auditor switches, audit market concentration, and lowballing.
    Purpose of the Study:

    Increasingly, regulators, standard setters, and audit clients have expressed concern over the level of concentration in the U.S. audit market. The primary concern is that audit market concentration could result in higher fees for audit clients, which is supported by economic theory that suggests a positive association between concentration within an industry and industry prices. Despite this theory and the concerns that exist, the association between increased concentration within the U.S. audit market and audit fees remain unclear. Previous studies have examined this issue with mixed results. As a result of the mixed evidence that exists, the authors choose to re-examine the association between audit market concentration and audit fees. 

    Design/Method/ Approach:

    The authors use two settings to examine whether and how audit market concentration affects audit fees. First, they examine how concentration is related to audit fees in a sample of stable auditor-client relationships. Next, they examine how audit market concertation affects audit fees in a sample of firms that switch auditors. They conduct these examinations using a large sample of U.S. audit engagements covering the years 2000 – 2013.    

    Findings:
    • The authors find, in their test of non-changing audit clients, a significantly positive association between audit market concentration and audit fees.
      • The authors find that the positive association is driven by the inclusion of MSA-level indicator variables in the audit fee model that they chose. For example, when they control for MSA-level fixed effects in their models, they find the association between audit market concentration and audit fees changes from significantly negative to significantly positive.
    • The authors’ test of initial audit fee discounts indicates that increases in concentration significantly reduce the discounts.
    • The authors provide some evidence that the effect of local audit market concentration on audit fees is more pronounced for smaller clients.
    • The authors find that concentration is positively associated with audit quality, as proxied by abnormal accruals. 
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions
  • Jennifer M Mueller-Phillips
    Audit Pricing for Strategic Alliances: An Incomplete...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity 
    Title:
    Audit Pricing for Strategic Alliances: An Incomplete Contract Perspective
    Practical Implications:

    This paper adds a new dimension to the research on strategic alliances by focusing on auditing rather than governance, performance, funding, or equity participation. It also identifies incomplete contracts as the driver of audit complexity, and extends the audit fee literature by documenting that the number of strategic alliances is a significant determinant of audit fees. Finally, the authors’ evidence that strategic alliances result in higher audit fees provides empirical support for the largely theoretical argument that incomplete contracts are complex. 

    Citation:

    Demirkan, S. and N. Zhou. 2016. Audit Pricing for Strategic Alliances: An Incomplete Contract Perspective. Contemporary Accounting Research 33 (4): 1625-1647.

    Purpose of the Study:

    A strategic alliance is a long-term contract between multiple firms where resources are pooled to accomplish preset objectives, creating dependence between otherwise legally independent firms. Prior research has focused on the emergence, management and survival of alliances; consequently, there is not substantial research on the relation between strategic alliances and auditing. This paper fills that void by investigating how auditors price their audit services for firms involved in strategic alliances. 

    Design/Method/ Approach:

    The authors conduct a study on the pricing of audit services for strategic alliances through compiling data and utilizing descriptive statistics.  

    Findings:
    • The authors find that the nonverifiability of information and potential agency behavior in alliances increase audit complexity, resulting in higher audit fees.
    • The authors find that auditors are less likely to issue going-concern modified opinions when there is an increase in strategic alliances; moreover, an increase in strategic alliances is associated with a reduction in bankruptcy risk as measured by Altman Z-Scores.
    • The authors find that an increase in strategic alliances is unrelated to the likelihood of financial misstatements.
    • The authors find that an increase in strategic alliances is unrelated to internal control weakness opinions. 
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Business Risk Assessment (e.g. industry - IPO - complexity)
  • Jennifer M Mueller-Phillips
    Auditor Fees and Auditor Independence: Evidence from Going...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions
    Practical Implications:

    The finding of this study suggest that concerns over the relation between auditor fees and the possible impairment of auditor independence, as reflected in going concern modification decisions, are supported in the more recent years for highly distressed clients. The relationship between auditor fees and impairment of auditor independence with respect to auditor decision-making has long been a concern of many regulators in the accounting industry. This research may inform both audit firms and standard setters with respect to specific types of engagements and the judgments or behaviors most likely to be affected.

    For more information on this study, please contact Allen D. Blay.
     

    Citation:

    Blay, A. D., and M. A. Geiger. 2013. Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions. Contemporary Accounting Research 30 (2).

    Keywords:
    auditor fees; auditor independence; going concern; regression analysis
    Purpose of the Study:

    The possible adverse effect of auditors providing services to clients who pay them directly has historically been a concern of the public accounting profession. Without independence there is no need for external auditors attesting to the purported accuracy and completeness of company financial statements. The association between fees received by audit firms directly from clients and the possible impairment of auditor independence, particularly with respect to going concern decisions, continues to be of considerable interest to regulators and others. This study assesses the potential impairment of auditor independence in the context of going concern reporting.

    Design/Method/ Approach:

    The authors derive their findings examining the association between both current and future audit service and nonaudit service fees received by U.S. auditors and the type of opinion rendered to a financially distressed client. To achieve their sample, the authors used the Audit Analytics database and first identified firms that received a going concern modified (GCM) audit opinion in the years 2004-2006. They also identified firms that had both negative income and cash flows from operations in the same year but did not receive a GCM opinion. Finally, the authors tested their hypotheses by using a research model to determine the probability of issuing a GCM audit opinion to a financially distressed client. 

    Findings:

    A negative correlation exists between future fees paid to auditors and auditor going concern opinion decisions.
    Higher levels of current nonaudit service fees paid to auditors reduces the frequency of going concern opinion modifications in the more recent 2004-2006 time period when using a more stringent control sample of financially distressed firms.
    Findings related to going concern decisions and nonaudit service fees in the United States are sensitive to both the time period examined and the selection of appropriate control samples of distressed non-GCM firms.
    A negative association exists between current nonaudit service fees and total subsequent fees paid to auditors.
     

    Category:
    Auditor Judgment, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Going Concern Decisions, Impact of Fees on Decisions by Auditors & Management
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization, Service Bundling, and...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual 
    Title:
    Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City.
    Practical Implications:

    The authors contribute by providing some of the first evidence of service bundling in the economics of auditing literature. In doing so, they broaden the notion that strategic pricing occurs around audit switches. This study contributes to prior mixed findings of the existence of industry specialist premiums in the small-client segment, suggesting an additional reason why these mixed findings might occur. Where opportunities to package services are attractive, auditors may strategically price and discount audits with bundling premiums in mind. Where potential for such bundling opportunities is less attractive, it is possible the auditor may instead seek to generate premiums in the audit service.

    Citation:

    Ferguson, A., G. Pündrich, and A. Raftery. 2014. Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City. Auditing: A Journal of Practice & Theory 33 (3): 153-180.

    Keywords:
    audit fees, industry specialization, mining industry, non-audit services, second-tier firms, service bundling
    Purpose of the Study:

    This study examines auditor industry specialization effects in Perth, a remote mining town in Australia characterized by a large number of small, homogeneous firms. In this study, the authors consider whether an auditor industry specialist may strategically price a bundle of services in the small-client segment. They argue that the small company sector is a good environment to consider the existence of service bundling. The setting is the mining development stage entity (MDSE) market in Perth, the biggest industry and city in Australia by client numbers. This market is characterized by small (high-growth) firms where auditing is arguably of less importance to the client compared to tax advisory, the other primary service provided to them. Further, the firms are relatively homogeneous, an appealing feature of industry studies. Thus, the authors have arguably an attractive setting to observe service bundling by an industry specialist.

    First, the authors examine whether industry specialist auditors earn audit fee premiums in the Perth MDSE segment. To do this, an audit pricing model is developed and includes controls likely to impact on audit fees in a mining industry context. Second, the authors redefine the dependent variable to consider the pricing implications of the bundle of services provided by industry specialists.

    Design/Method/ Approach:

    The authors utilize an OLS regression model to test for audit fee premiums with respect to brand name and industry leadership. A sample of 1,799 firms listed on the ASX as of December 31, 2009 is obtained. Of the 1,799 listed entities nationally, 668 (37.13 percent) are domiciled in Perth, making it the largest city-level market by client numbers in Australia. At the city-level, the market share of non-Big 4 firms is 70.1 percent in Perth.

    Findings:

    The authors find no evidence of auditor industry leadership audit fee premiums accruing to either Big 4 (EY) or non-Big 4 (BDO) leaders. However, when the dependent variable is redefined to include non-audit services (NAS), the industry leader, BDO, obtains a total fee premium. This finding is of added interest given that the industry leader is a second-tier firm, implying that strategic audit pricing, such as service bundling, is not confined to Big 4 auditors. Nor is it confined to merely one location, since bundling premiums are observed at the national level. The authors argue MDSEs have little in the way of financial statement complexity, so they do not value specialist audits, but rather are willing to pay more for NAS. Last, in supplementary analysis, the authors find some evidence of partner-scale effects.

    Category:
    Audit Team Composition, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Industry Expertise – Firm and Individual, Non-audit Services
  • Jennifer M Mueller-Phillips
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality...
    research summary posted March 4, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size, 14.0 Corporate Matters 
    Title:
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics?
    Practical Implications:

    The fact that the Big 4 effect is generally insignificant indirectly supports the argument that the Big 4 distinction may reflect client and not auditor characteristics. The results suggest that differences in these proxies between Big 4 and non-Big 4 auditors largely reflect client characteristics and, more specifically, client size. The study has not resolved the question, although it encourages other researchers to explore alternative methodologies that separate client characteristics from audit-quality effects.

    For more information on this study, please contact Alastair Lawrence.

    Citation:

    Lawrence, A., M. Minutti-Meza, and P. Zhang. 2011. Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics? The Accounting Review 86 (1): 259-286. 

    Keywords:
    Big 4 versus non-Big 4 audit quality; discretionary accruals; ex ante cost-of-equity capital; analyst forecast accuracy; propensity-score matching; attribute-based matching
    Purpose of the Study:

    This study examines whether differences in proxies for audit quality between Big 4 and non-Big 4 audit firms could be a reflection of their respective clients’ characteristics.

    The question of Big 4 superiority is important, given that many studies rely on the Big 4 versus non-Big 4 distinction as an audit-quality proxy. Hence, it is prudent to confirm that this distinction does not simply reflect client characteristics. Furthermore, incorrectly classifying Big 4 auditors as superior to non-Big 4 auditors has unnecessary negative ramifications for smaller auditors, such as audit committee’s auditor selection bias and discriminatory clauses in loan and underwriting agreements, which could result in a loss of current and future clients.

    Design/Method/ Approach:

    In the research, the authors use three audit-quality proxies – discretionary accruals, the ex ante cost-of-equity capital, and analyst forecast accuracy – and employ propensity-score and attribute-based matching models in attempt to control for differences in client characteristics between the two auditor groups while estimating the audit-quality effects. Also, they use propensity-score matching models in an attempt to control for differences in client characteristics between the two auditor groups while estimating auditor treatment effects.

    Findings:

    Using the matching models and full samples, the authors find that the treatment effects of Big 4 auditors are insignificantly different from those of non-Big 4 auditors with respect to our three audit-quality proxies.

    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Corporate Matters
    Sub-category:
    Audit Fee Decisions, Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    CEO and CFO Equity Incentives and the Pricing of Audit...
    research summary posted October 20, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 14.0 Corporate Matters, 14.01 Earnings Management, 14.07 Executive Compensation 
    Title:
    CEO and CFO Equity Incentives and the Pricing of Audit Services
    Practical Implications:

    Our study highlights the importance of taking into account executive incentive plans in improving the understanding of auditors’ risk assessment and pricing decisions, in support of the current professional audit standards. The findings that auditors respond to CEO and CFO equity incentives differently have significant implications for the corporate governance reforms and the design of optimal corporate executive compensation policies. Following the accounting scandals in the early 2000s, there has been increased regulatory and legislative scrutiny on corporate governance. Especially, regulators have recognized CFOs as the individuals bearing responsibilities for the integrity of financial information. Our paper lends support to the regulatory inclusion of CFOs as accountable individuals, and to concerns that firms should exercise caution in compensating CFOs using equity-based tools.

     

    For more information on this study, please contact Yonghong Jia.

    Citation:

    Billings, B. A., X. Gao, and Y. Jia. 2014. CEO and CFO Equity Incentives and the Pricing of Audit Services. AUDITING: A Journal of Practice & Theory 33 (2): 1-25

    Keywords:
    Audit fees; auditor risk assessment; equity incentive; accounting manipulation
    Purpose of the Study:

    The alleged perverse role of managerial incentives in accounting scandals and the distinctive role of auditors in identifying and intervening in attempted earnings manipulation, highlight the importance of explicitly considering executive incentive plans by auditors in the auditing process. However, there is little systematic evidence on auditors’ responses to the sizable holdings of equity by executives, a phenomenon that is particularly common in US public companies. In this paper, we investigate the association between executive equity incentives and auditors’ risk assessment and consequently audit pricing decisions. We examine auditors’ responses to equity incentives for CEOs and CFOs separately and jointly and inquire whether the responses are different.  

    Design/Method/ Approach:

    We gather information on audit fees, non-audit fees, auditors, internal control information from AuditAnalystics, executive compensation data from ExecuComp, and financial variables from Compustat, for the years 2002 through 2009. We estimate standard audit fee regression models that include variables to capture executive equity incentives and control variables that are identified to be determinants of audit fees by prior studies. 

    Findings:

    Using different measures of executive equity incentives and following standard audit service pricing research designs, we document compelling evidence that auditors adjust the price of their audit services upward in response to CFO equity incentives, suggesting that auditors perceive heightened audit risk associated with CFO equity incentives. We find some evidence that auditors view CEO equity incentives as innocuous or even beneficial in term of audit risk. We further demonstrate that the presence of internal control problems augments the positive relation between CFO equity incentives and audit fees, suggesting particularly elevated risk concerning CFO equity incentives perceived by auditors when internal controls are flawed. 

    Category:
    Client Acceptance and Continuance, Corporate Matters
    Sub-category:
    Audit Fee Decisions, Client Risk Assessment, Earnings Management, Executive Compensation
  • Jennifer M Mueller-Phillips
    CEO Equity Incentives and Audit Fees.
    research summary posted September 15, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management 
    Title:
    CEO Equity Incentives and Audit Fees.
    Practical Implications:

    According to the authors, stock options and restricted stocks are important components in CEO compensation. This study shows that auditors do perceive greater audit risk due to CEO equity compensation adjust pricing decisions accordingly. Auditors appear more concerned about CEO’s incentives to increase a company’s risky behavior so as to the CEO’s equity based compensation as opposed to increasing stock price specifically. As a CEO’s vega (i.e. change in value of a manager’s equity portfolio due to a change in stock return volatility) increases, a manager becomes less risk averse and more willing to engage in risky behavior such as earnings management. This study offers additional insights into the cost/benefits of equity based compensation.

    Citation:

    Kim, Y., H. Li, and S. Li. 2015. CEO Equity Incentives and Audit Fees. Contemporary Accounting Review 32 (2): 608-638.

    Keywords:
    Stock Option Compensation, Audit Fees, Earnings Management
    Purpose of the Study:

    This study examines the relationship between CEO equity incentives and audit risk assessment and pricing. More specifically, it examines whether/how auditors perceive CEO equity as a risk factor and incorporate into their audit pricing decisions. The authors also seek to start reconciling prior mixed evidence regarding equity incentives and earnings management and determine whether earnings management risk is due to equity compensation’s (i.e. manager’s wealth) relationship with stock return volatility (i.e. risk) or stock price. This study refines insights into the determinants of audit risk/pricing decisions and links two literatures, executive compensation and auditor compensation.

    Design/Method/ Approach:

    Sample: S&P 1500 companies over 20002009
    Source: Audit Analytics (Audit Fees), COMPUSTAT’s ExecuComp (CEO compensation)
    ModelOLS with Log Audit Fees regressed on Log CEO Vega, Log CEO Delta, Audit Fee determinants from previous studies, and year/industry fixed effects

    Findings:

    Findings show that a CEO’s portfolio vega (i.e. change in value of a manager’s equity portfolio due to a change in stock return volatility) is the important determinant of audit risk/pricing and subsumes the effects found in the previous research of a CEO’s portfolio delta (i.e. change in value of a manager’s equity portfolio due to a change in stock price) on audit risk/pricing.

    Additional analyses/results include:  

    • Repeat main analysis for CFO equity incentives. No association found.
    • Examining “direct” effect of equity incentives on audit fees (i.e. general complexity of auditing stock-based compensation) by exploring post SFAS 123R period requirements to fair value nonexecutive employees’ stock options. No association found.
    • Alternative measures of CEO equity incentives including total options held by CEO, percent of CEO equity compensation of total CEO compensation, and broader measures of CEO equity compensation. Similar results to main results.

    Results are robust to several endogeneity tests including:

    • First time options grants and changes in audit fees model
    • Inclusion of firm fixed effects
    • Instrumental variables approach
    • Dynamic panel GMM estimation (Arellano-Bond system GMM estimator)
    • Additional controls for riskiness of firm investment and financial policies
    Category:
    Client Acceptance and Continuance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Audit Fee Decisions, Client Risk Assessment, Earnings Management, Earnings Management
  • Jennifer M Mueller-Phillips
    CEO Turnover and Audit Pricing.
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment 
    Title:
    CEO Turnover and Audit Pricing.
    Practical Implications:

    Voluntary turnover of a CEO does no effect the audit fees of a company. Forced CEO turnover causes the business risk of both the client and the auditor to increase. Thus, audit fees increase. The study has practical implications for companies, by estimating the extra audit costs associated with forced CEO turnover.

    Citation:

    Huang, H., Parker, R. J., Yan, Y., & Lin, Y. 2014. CEO Turnover and Audit Pricing. Accounting Horizons 28 (2): 297-312.

    Keywords:
    audit fees, audit risk, CEO turnover
    Purpose of the Study:

    Accounting researchers have expended considerable resources over the last thirty years investigating factors that influence the audit fees charged by accounting firms. Researchers have found that accounting firms consider the risks of an audit in determining the audit price and that higher risk results in higher prices.

    This study examines the relationship between CEO turnover in client companies and the fees charged by their audit firms. According to the proposed theoretical framework, forced turnover is associated with higher risk for the auditing firm and, consequently, higher audit prices. The authors propose that forced CEO turnover (such as dismissals) pose higher business and audit risks for the audit firm than voluntary turnover (such as retirements); further, greater risk leads to higher audit prices. Forced CEO turnover often is a signal that the board of directors believes that corporate leadership and strategy need to change. This change, in turn, results in uncertainties regarding the competency of a new CEO and the effectiveness of a new strategy. The business risk of both the client and the auditor increases.

    Design/Method/ Approach:

    The authors develop two related regression models to examine audit fees. From the Audit Analytics database, the authors obtain a final sample of 13,692 firm-year observations with audit fees from 2004 to 2011. Of these, there were 1,030 cases with a CEO turnover (7.5 percent of total observations), including 166 observations with forced CEO turnover and 864 observations with voluntary turnover. Voluntary retirement is classified as a CEO who is 60 or older.

    Findings:

    Results for both models indicate that firms with forced CEO turnover have significantly higher audit fees than firms with either voluntary turnover or no turnover. Further, the authors find no difference in audit fees between companies with voluntary turnover and companies without turnover.

    Firms with forced CEO turnover have higher audit fees than both firms with voluntary turnover (mean difference of $763,000, p , 0.001) and firms with no turnover (mean difference of $858,000, p , 0.001); these results suggest forced CEO turnover has a meaningful economic difference. The authors find similar results in a model that examines change in audit fees from the prior year. Firms with forced CEO turnover have a larger increase in audit fees than both firms with voluntary turnover ($956,000 difference, p , 0.001) and firms with no turnover ($1,135,000 difference, p , 0.001).

    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Client Risk Assessment
  • Jennifer M Mueller-Phillips
    Changes in Audit Market Competition and the Big N Premium
    research summary posted October 3, 2013 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes 
    Title:
    Changes in Audit Market Competition and the Big N Premium
    Practical Implications:

    The increase in the premium paid for a Big N auditor over a non-Big N auditor has increased over time and is associated with consolidation in the audit industry. This association is weaker for large global firms and more pronounced for medium and small size firms. From these results, the authors suggest that concerns regarding the impact on large global firms of consolidation in the audit market may be overstated.

    Citation:

    Carson, E., R. Simnett, B. S. Soo, and A. M. Wright. 2012. Changes in Audit Market Competition and the Big N Premium. AUDITING: A Journal of Practice & Theory. 31(3), 47-73.

    Keywords:
    audit fees; audit market; competition; regulation; longitudinal analysis
    Purpose of the Study:

    Since 1997, the number of large, global audit firms has decreased from six to four. This study responds to recent calls from government bodies for research into the market effects of this decline. The authors investigate the change in audit fees over the sample period to determine if there has been a significant decrease in competition in the audit market.

    Design/Method/ Approach:

    The authors use data on audit fees from ninety percent of nonfinancial listed Australian firms between the years 1996 and 2007, which spans the time window of the decline from the Big 6 to the Big 4 audit firms. The authors use the Big N premium, the difference between a Big N audit fee and what a client could pay for a non-Big N auditor, as their dependent measure and control for relevant changes in the economy over the period.

    Findings:

    The study provides evidence that the overall Big N Premium has increased significantly from the Big 6 period to both the Big 5 and Big 4 periods. Surprisingly, the premium for the largest global firms has not increased as greatly as the rest of the market, likely due to their relatively greater bargaining power. On the other hand, small and mid-size firms saw a larger jump in premiums over the time period.

    Category:
    Auditor Selection and Auditor Changes, Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions

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