Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    Fee Discounting and Audit Quality Following Audit Firm and...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    878 Views
    Title:
    Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence.
    Practical Implications:

    The study results are important to regulators and audit practitioners as they show the consequences of initial year audit fee low-balling on the performance of the audit. Lower audit quality occurs when an audit firm change includes a change to both audit partners along with a reduction in audit fees. This indicates that retaining one or both of the former audit partners in the new audit firm can offset the reduced audit quality effect in the initial years of the audit engagement. 

    Citation:

    Huang, H.-W., K. Raghunandan, T.-C. Huang, and J.-R. Chiou. 2015. Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence. The Accounting Review 90 (4): 15171546.

    Keywords:
    audit fees, auditor changes, audit quality
    Purpose of the Study:

    Global regulators have voiced concerns regarding the low-balling of initial audit fees and the effect on audit quality. Although prior studies in the United States provide evidence of the low-balling effect, the emergence of China as a global economic power provides motivation to examine the low-balling effect in the Chinese audit market. In addition, there is limited evidence on the audit quality effects of low-balling the initial audit fee.  

    This paper addresses whether: 1) the low-balling of initial audit fees occurs in China; 2) there is an association between the low-balling of initial audit fees and the type of audit partner change related to an audit firm change; and 3) the reduction of the initial audit fees influences low quality audits.

    The Chinese audit market expanded in the late 1990s primarily through mergers. In some cases, audit partners changed firms but retained their audit client base. With the public disclosure of audit partner names in China, the authors can determine if the audit firm change results in an audit partner change.  For this study, a normal audit firm change occurs when both of the audit partners are new to the audit engagement. For this normal change, the authors expect a higher instance of low-balling of initial year audit fees. Alternatively, if one or both of the audit partners continue on the audit engagement after an audit firm change, the authors expect a reduced low-balling effect.

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study. They obtain audit fees, financial data, return data, and corporate governance information from the China Center for Economic Research (CCER) database. Audit partner and audit firm information is from the Taiwan Economic Journal (TEJ) database. The sample period is from 2002-2012. All data is for clients listed on the Shanghai and Shenzhen stock exchanges.

    Findings:
    • The authors find evidence of the low-balling of initial audit fees in the Chinese audit market. Specifically, they show the greatest reduction in initial audit fees when the audit client engages a new firm and both of the audit partners are new to the engagement. Using an audit fee changes model, the initial audit fee discount is approximately 4% when both audit partners are new to the client. 
    • When evaluating audit quality, the authors find that audit sanctions from the Chinese regulator are more likely when there is an audit firm change with two new audit partners and an initial audit fee discount. Using discretionary accruals, they find consistent results with the sanctions results of lower audit quality. Using modified audit opinions, the results provide weaker evidence of lower audit quality than when using sanctions or discretionary accruals. 
    • The authors noted no evidence that audit partner changes, without a related audit firm change, result in lower audit quality.
    • Interestingly, the authors find that initial audit fee reductions become smaller over time and the association between fee reductions and lower audit quality is insignificant after the first two years of the audit.   
    Category:
    Audit Quality & Quality Control, Independence & Ethics, International Matters
    Sub-category:
    Audit Partner Identification by Name, Impact of Fees on Decisions by Auditors & Management