Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    An Experimental Investigation of the Influence of Audit Fee...
    research summary posted October 15, 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, 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management 
    423 Views
    Title:
    An Experimental Investigation of the Influence of Audit Fee Structure and Auditor Selection Rights on Auditor Independence and Client Investment Decisions
    Practical Implications:

     Lowballing has been cited as a threat to auditor independence and manager performance in regulatory reports and academic research. This study suggests that auditors may face independence issues at the beginning of a client relationship under the lowballing fee structure because of the uncertainty of retaining a client. The study also suggests, however, that these independence issues seem to dissipate over time. Therefore, auditors should be aware of these potential opportunities to lose objectivity when they acquire new audit clients and continue to rely on professional skepticism to evaluate management assertions.

    For more information on this study, please contact Darius J. Fatemi.
     

    Citation:

    Fatemi, D. J. 2012. An Experimental Investigation of the Influence of Audit Fee Structure and Auditor Selection Rights on Auditor Independence and Client Investment Decisions. Auditing: A Journal of Practice and Theory 31(3): 75-94.

    Keywords:
    Audit fees; auditor independence; experimental economics; manager investment; auditor selection.
    Purpose of the Study:

    The purpose of this paper is to investigate the effect of audit fee structure on auditors, their clients, and investors. The author wanted to specifically investigate how a lowballing audit fee structure as opposed to a flat rate fee structure impacts:

    • manager investment decisions
    • the degree of investigation of management decisions by auditors
    • the price that investors pay for shares of the company

    The author also investigated whether a cause-effect relationship exists between the use of a lowballing audit fee structure (in which auditors provide initial services at reduced prices but at higher prices in later periods) and auditor independence when retention is of concern to the auditor.

    Design/Method/ Approach:

    The author utilized an experimental market using undergraduate accounting majors that were randomly assigned to the roles of managers, investors, and auditors.  The auditors followed either a lowballing fee structure or a flat rate fee structure. Auditor selection was performed by either the managers or the investors. The managers bid on firm assets and provided a disclosure of the value of the assets to the investors. Auditors decided the extent to which they investigated managers’ claims and either concurred with manager’s disclosures or they provided information that the auditors believed to be more accurate.

    Findings:

    Compared to the flat-rate fee structure, managers under a lowballing fee structure scheme were:

    • more willing to make a high cost/return investment
    • more concerned with the credibility of their reports
       

    Auditor behavior is summarized as a response to past manager choices: when managers were especially willing to invest and be honest, auditors performed fewer tests of manager disclosures. Additionally, under manager selection and when lowballing existed, auditors attributed a higher accuracy to investigations indicating high manager investment than tests that suggest low investment, while accuracy assessments of favorable and unfavorable test results did not differ under investor selection. Finally, auditor retention under manager selection was negatively impacted by both unreliable auditing and disagreements with managers, but retention was only affected by unreliable auditing under investor selection.

    Category:
    Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Impact of Fees on Decisions by Auditors & Management