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    Small Audit Firm Membership in Associations, Networks, and...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.0 Audit Team Composition, 05.08 Impact of Office Size 
    Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees
    Practical Implications:

    The results of this study are important for regulators concerned about the lack of competition in the audit market for large publicly-traded companies.  These data indicate that audit firm associations can increase competition in this sector of the market by providing small firms with the necessary resources to adequately audit large, global, and complex audit clients.  These findings should also be of interest to small audit firms interested in better serving larger audit clients.  Lastly, these results should be of interest to corporate governance bodies and investors interested in the relationship between audit firm type and audit quality.


    Bills, K. L., L. M. Cunningham, and L. A. Byers. 2016. Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees. The Accounting Review 91 (3): 767-792.

    associations; networks; small audit firms; audit fees
    Purpose of the Study:

    Small audit firms are often restricted in their ability to audit large public companies because these companies often have global operations and complex business and financial reporting environments which demand a level of resources difficult for smaller firms to provide.  Many of these small firms seek membership in accounting firm associations in an effort to overcome these barriers.  Accounting firm associations are autonomous organizations in which all firm members are independent in legal name and structure, but membership affords participating firms access to resources provided by the association itself as well as fellow association members.

    Because accounting firm associations can pre-screen affiliate members and provide access to resources that would otherwise be more difficult or costly for small audit firms to obtain, audit quality for the clients of these affiliate members is likely to be higher than the clients of unaffiliated small audit firms.  Addressing this issue is important because over half of all publicly traded companies are audited by small audit firms and little accounting research to date examines differences in audit quality across the clients of small audit firms.  Below are three objectives the authors address in their study:

    • Examine whether audit quality is higher for clients of affiliated audit firms relative to the level of quality provided by nonmember firms.  The pre-screening process and access to additional resources is expected to result in higher quality for affiliated small audit firms relative to unaffiliated small audit firms.
    • Examine whether clients who choose to engage an affiliated small audit firm pay a fee premium.  If membership in an accounting firm association is associated with a perceived reputation for higher audit quality, then audit fees for affiliated small audit firms should be higher relative to unaffiliated small firms.
    • Examine whether the potential increase in audit quality associated with membership in an accounting firm association affects the extent to which audit quality differs between Big 4 firms and small, but affiliated audit firms. While prior research indicates audit quality is lower for small audit firms relative to Big 4 firms, affiliation in an accounting firm association may provide small firms with the additional resources necessary to close this gap.
    Design/Method/ Approach:

    The authors use hand-collected audit firm association membership data from 2010-2013, along with financial statement data for publicly traded firms, to examine whether audit quality and audit fees for publicly traded clients differs between small audit firms affiliated with an audit firm association and small firms with no such affiliation.  Audit quality was measured using PCAOB inspection findings, financial statement misstatement rates, and differences in levels of client discretionary accruals.

    • Affiliated small audit firms provide on average higher quality audits to their publicly traded clients relative to small, un-affiliated audit firms.  In particular affiliated small audit firms are less likely to receive accounting related deficiencies, or audit related deficiencies in their PCAOB inspection reports.  In addition, the clients of affiliated members report fewer annual financial statement misstatements, and less extreme discretionary accruals.  In addition, the findings indicate that when a small audit firm joins an accounting firm association, audit quality increases in subsequent years.  Lastly audit quality is increasing in the size of the audit firm association.  This indicates that the increase in audit quality is driven by an increased access to valuable resources provided by the affiliation.
    • Affiliated small audit firms receive an audit fee premium from their clients relative to unaffiliated small audit firms and this premium is increasing in the size of the audit firm association. 
    • The researchers observe no significant differences in audit quality between affiliated small audit firms and Big 4 firms.  This indicates that affiliated small audit firms provide high-quality audits to large publicly-traded companies.  In addition, while affiliated small audit firms experience a fee premium relative to unaffiliated firms, these fee premiums remain lower than those experienced by Big 4 firms.
    Audit Team Composition, Auditor Selection and Auditor Changes
    Auditor Qualifications (e.g. size - industry expertise), Impact of Office Size