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    A Reexamination of Audit Fees for Initial Audit Engagements...
    research summary posted December 3, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 04.0 Independence and Ethics 
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    Title:
    A Reexamination of Audit Fees for Initial Audit Engagements in the Post-SOX Period
    Practical Implications:

    The results of the study strongly suggest that initial-year audit discounts are quite common and substantial in the post-SOX period. Although the existence of lowballing seems to be a threat to independence, at least in appearance, the existing research on lowballing provides mixed results on its impact on audit quality. The findings will likely be of interest to the PCAOB as it searches for ways to bolster auditor independence and other regulators because many, including the GAO, believe that without non-audit service fees, auditors are less likely to offer ‘‘loss-leader’’ fees for audits.

    For more information on this study, please contact Rosemond Desir.

    Citation:

    Desir, R., J. R. Casterella, and J. Kokina. 2014. A Reexamination of Audit Fees for Initial Audit Engagements in the Post-SOX Period. Auditing: A Journal of Practice & Theory 33 (2):  59-78

    Keywords:
    Audit fees, auditor independence, lowballing, PCAOB
    Purpose of the Study:

    On August 16, 2011, the Public Company Accounting Oversight Board (PCAOB) issued a concept release seeking comments on ways to enhance auditor independence. The Board notes that higher failure rates in new audit engagements might be linked to unrealistic pricing. The Board’s concern is that a new auditor might be more susceptible to management pressure if initial-year audit fees are set artificially low.

    Prior to the passage of the Sarbanes-Oxley Act (SOX) of 2002, empirical evidence shows that auditors discounted their initial-year audit fees. This practice is known as lowballing and it occurs when auditors price initial-year audit fees lower for new clients with the expectation of increasing the fees substantially in later years in order to recoup their initial losses. Lowballing was expected to decrease significantly after the enactment of SOX.

    Indeed, findings of a study on audit pricing in initial-year audits seem to confirm that Big 4 auditors charged a fee premium on new auditor-client relationships in 2006. However, it is not clear if more recent post-SOX initial-year audits are free of lowballing. In the current study, the authors investigate whether lowballing exists in new auditor-client relationships in an ‘‘extended’’ post-SOX environment for the years 2007 to 2010. 

    Design/Method/ Approach:

    The authors analyze audit fee data for years 2006 through 2010 for publicly-traded companies that are Big 4 and non-Big 4 clients. The focus of the study is on initial audits following auditor dismissals as there are very few auditor resignations. The audit fee data were collected from Audit Analytics database and financial data – from Compustat.

    Findings:

    The results suggest that both Big 4 and non-Big 4 accounting firms discounted their initial-year audit fees during the sample period (2007–2010), with fee discounts ranging from 16 to 34 percent. In addition, the authors find no evidence of initial-year audit fee discounts (or premiums) in 2006. 

    Category:
    Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc