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    Audit Fees for Initial Audit Engagements Before and After...
    research summary posted April 23, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions 
    Audit Fees for Initial Audit Engagements Before and After SOX
    Practical Implications:

    This study provides an analysis of initial-year audit fee discounts/premiums in the pre-SOX era (2001) and post-SOX era (2006). 
    The findings from this study suggest that concerns over initial-year audit fee discounts are not supported by empirical evidence in the post-SOX era, at least for the Big 4 auditors.  Additionally, this study provides empirical evidence that suggests the Big 4 have become more conservative in their client acceptance and pricing decisions in the post-SOX era.  The authors note that these results
    should be of interest to clients, auditors, and regulators, given the concerns expressed by regulators and legislators about the adverse consequences associated with initial-year fee discounts.


    Huang, H-W., K. Raghunandan, and D. Rama.  2009.  Audit Fees for Initial Audit Engagements Before and After SOX.  Auditing: A
    Journal of Practice and Theory
    28 (1): 171-190

    : Audit pricing, auditor-client relationships, audit engagements, start-up costs, SOX, legislators
    Purpose of the Study:

    The purpose of this study is to examine initial-year audit fee discounts (i.e. “lowballing”) in the post-SOX era.  The study is motivated by concerns (from legislators, regulators, and the media) that auditors “lowball” initial-year audit fees in order to gain the job and that such lowballing can lead to reduced audit quality.  The authors discuss five factors that likely reduced lowballing of audit fees in the post-SOX era: 

    • Audit firms are more likely to price auditing as a stand-alone service and less likely to lowball audit fees to gain certain nonaudit service contracts, which are restricted by SOX.
    • Audit firms became more conservative in the post-SOX era and the increased conservatism is reflected in first-year fee pricing.
    • SOX 301 requires that the audit committee (instead of management) be responsible for compensating auditors. This could reduce client’s audit fee negotiation since the incentives of audit committee members (reputation) can be different from the incentives of management (cost-cutting).
    • The failure of Arthur Andersen led to a more concentrated audit market, which in turn changed the dynamics of audit pricing.
    • SOX 404 imposed significant additional demands on manpower resources and initial-year engagements, as well as presented a new source of revenues for auditors. 

    This study compares audit fees in the pre-SOX and post-SOX periods to determine whether lowballing of audit fees for initial-year audits becomes less likely in the post-SOX era.

    Design/Method/ Approach:

    The authors use data on U.S. publicly-traded non-financial companies for pre-SOX (2001) and post-SOX (2006) fiscal year-end audits. For each period, they compare audit fees (or change in audit fees) of first-year engagements with those of subsequent-year engagements to determine initial-year fee discounts or premiums. 

    The authors examine Big 4 and non-Big 4 clients separately. They exclude auditor resignations and the switches from Big 4 to non-Big 4 (and vice-versa).

    • Pricing for initial-year audits for the Big 4 clients is significantly different in the post-SOX era, as compared with the pre-SOX era.
      • Big 4 clients received an initial-year audit fee discount of 24% in 2001.
      • Big 4 clients paid an initial-year audit fee premium of 16% in 2006.

    The authors suggest this implies that for the Big 4 auditors, concerns over initial-year discounting of audit fees are not supported by empirical evidence in the post-SOX period. 

    • As for non-Big 4 clients, the authors find some evidence (when examining the changes in audit fees from the preceding fiscal year) that non-Big 4 clients received initial-year fee discounts both in 2001 and 2006. The authors suggest this implies that competition is more intense in the non-Big 4 segment of the audit market in the post-SOX period, when compared to the Big 4 segment. 
    • Several interesting observations are noted by the authors:
      • Auditor resignations are more likely in 2006 than in 2001.
      • There are very few instances of a Big 4 firm serving as a successor auditor following the resignation of a predecessor auditor.
      • The likelihood of a Big 4 successor following a client-initiated dismissal is lower in 2005-2006 than in 2001.  The authors argue this implies that the Big 4 became more conservative in accepting new clients and/or non-Big 4 became more aggressive following SOX.
    Client Acceptance and Continuance
    Audit fee decisions
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