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    Effect of Client Reputation on Audit Fees at the Office...
    research summary posted February 20, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
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    Title:
    Effect of Client Reputation on Audit Fees at the Office Level: An Examination of S&P 500 Index Membership
    Practical Implications:

    The results of this study are important for audit firms to consider when they choose their clients.  The evidence indicates that auditors can benefit from client’s reputation by using it for advertising audit quality. Promotion of audit quality via the presence of reputed clients in the portfolio enables the auditors to negotiate favorable audit pricing from their other clients.    

    For more information on this study, please contact Dr. Sharad Asthana.

    Citation:

    Asthana, S. C., and R. Kalelkar. 2014. Effect of Client Reputation on Audit Fees at the Office Level: An Examination of S&P 500 Index Membership. AUDITING: A Journal of Practice & Theory 33(1): 1-27.

    Keywords:
    Auditor reputation; client reputation; S&P 500 index; audit fees; rent extraction; cost recovery
    Purpose of the Study:

    The impact of a decline in the reputation of the auditor or a client on other clients of the auditor is well documented. However, the effect of an unexpected increase in a client’s reputation on the auditing environment has never been examined. The authors try to fill the gap in extant research by examining the outcome of the addition of a client to the prestigious S&P 500 Index on the audit office and other clients of this office.

    The authors posit that the inclusion of a client in the S&P 500 index will have two outcomes. First, inclusion of a client in the S&P 500 index will increase the client’s visibility and monitoring by external agencies, thus improving its reporting quality. As a result of the improved reporting quality, the audit office will be willing to grant audit fee discounts to this client.

    Second, inclusion of a client in the S&P 500 index will have an impact on the audit fees of other clients in the audit office portfolio. An audit office’s association with an S&P 500 client is expected to have a positive impact on the office’s perceived audit quality. Once the perception of the auditor’s reputation in the local audit market is improved, other clients will be willing to pay higher remunerations for the audit services. Thus, the audit office is likely to increase their audit fees for non- S&P 500 clients to extract rent for its enhanced reputation.

    The authors motivate their expectations based on the marketing literature that suggest that branding and service differentiation could lead to increased market power and higher prices when firms are successful in differentiating their services or developing brand value. 

    Design/Method/ Approach:

    The research evidence is collected in the post-Sarbanes-Oxley period from 2003 to 2012.  The authors use clients of Big 4 audit offices that did not change auditors in the sample period. The authors divide clients into two groups: 1) S&P 500 clients if the clients are in the S&P 500 index during the sample period, and 2) non-S&P 500 clients if the clients were never in the S&P 500 index during the sample period.  

    Findings:
    • The authors find that the audit fees are discounted for S&P 500 clients (reputed clients) when it enters the index. The audit fee for this client increases following its exit from the index. The change in the audit fees correspond with the change in reporting quality of the firm. 
    • The authors find increases in the audit fees of non-S&P clients of the audit office following the increase in the S&P 500 clients in the auditors’ portfolio. Additional test reveals that increase in the audit fees is not supported by improvement in the reporting quality of other non S&P clients.
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fee Decisions, Audit Fees & Fee Negotiations