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    The Pricing of National and City-Specific Reputations for...
    research summary posted May 7, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications 
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    Title:
    The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market
    Practical Implications:

    This study has practical audit client portfolio management implications for audit firms seeking to earn audit fee premiums for reputations of industry expertise. For example, auditors’ reputations for industry expertise are neither strictly national nor strictly local.  One interpretation with practical implications for such firms is that national level or city level reputations for industry expertise are not individually sufficient to maximize fee premiums.  Rather, auditors can most effectively earn fee premiums when they establish both city-level and national-level reputations for industry expertise.

    Citation:

    Francis, J. R., K. Reichelt, and D. Wang.  2005.  The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market.  The Accounting Review 80 (1): 113-136.

    Keywords:
    Auditor industry expertise, Big 5 accounting firms, audit fees
    Purpose of the Study:

    The purpose of this study is to examine the pricing of Big 5 industry expertise in the United States based on national and city level reputations for industry expertise.  

    Industry knowledge and expertise help auditors build reputations that auditors can use to negotiate fee premiums.  Prior research suggests that industry knowledge and expertise is developed by investments in accounting professionals and their experiences in serving clients out of city-based practice offices.  However, auditors can build national reputations for industry expertise that may enable them to negotiate audit fee premiums as well.  The authors argue that the central issue in the “national” vs. “city” perspective on industry expertise is the degree to which office-specific expertise is transferrable throughout a firm. Specifically, the national perspective assumes accounting firms capture the industry expertise of its office-based professionals and distribute it throughout the entire firm.  Conversely, the city perspective assumes that auditor expertise is indelibly tied to individual professionals and cannot be distributed throughout the firm.  This study examines industry specialization audit fee premiums at the city level and national level to analyze how auditor reputations for industry expertise are viewed.  Specifically, the authors use U.S. fee disclosures to investigate audit pricing in the U.S.  audit market in order to determine: 

    • whether there is evidence that Big 5 auditor industry expertise is priced in the U.S. audit market 
    • whether the market for audit fees prices a Big 5 firm’s national (firm-wide) reputation or city-specific (local-office) reputations for industry expertise
    Design/Method/ Approach:

    The study uses data on U.S. non-financial publicly-traded companies with Big 5 auditors during the fiscal years 2000 and 2001.  The authors investigate audit fee premiums resulting from:

    • National specialization only,
    • City specialization only, and
    • Combined city and national specialization.
    Findings:
    • There is evidence of a fee premium of 19% on engagements where Big 5 auditors are both the nationally top-ranked auditor and the city-level industry leader in the city where the client is headquartered. The authors argue this indicates that national and city-specific industry leadership jointly impact auditor reputation and pricing. 
    • The magnitude of the premium for joint national-city leadership is bigger for larger clients (22 percent) than for smaller clients (7 percent).  
    • There is evidence of a fee premium of 8% on engagements where Big 5 auditors are the city-specific industry leader but not the national industry leader.  The authors argue this may indicate that auditor industry expertise is tied to individual professionals. However, the result is sensitive to test methods so the evidence is inconclusive on this point. 
    • There is no evidence of a fee premium for auditors that are national industry leaders alone without also being city-specific industry leaders.  The authors argue this indicates that national leadership alone does not result in a premium. 

    The authors argue these findings suggest that an auditor’s reputation is priced into audit fees as if both firm-wide (national) and city-specific (local) reputations are jointly relevant.

    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Audit fee decisions, Auditor Qualifications (e.g. size - industry expertise)
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