Client Importance and Audit Quality at the Individual Audit Partner,Office, and Firm Levels

We investigate whether audit partner level data provides a more powerful measure than office or firm level measures of client importance. We find that the likelihood of issuing a going-concern opinion (any and first-time) increases, and the absolute value of discretionary accruals decreases, in relation to the proportion of audit fees to the total audit fees received by audit partners from all their clients. We also find that the likelihood of issuing a going-concern opinion (any and first-time) increases, and the absolute value of discretionary accruals decreases, in relation to the proportion of non-audit services fees from a client to total non-audit service fees, and the proportion of total audit and non-audit service fees from a client to total fees from all their clients at the office and firm levels. Our findings provide evidence to regulators, audit clients, and stakeholders that audit partners do not succumb to pressure from economically more important clients as audit quality has a positive association with client importance.     

Costs Associated With Going-Concern-Modified Audit Opinions: An Analysis of the Australian Audit Market

This article examines the potential costs to Australian auditors and their clients from the issuance of first-time going-concern-modified audit opinions. We examine the population of Australian companies receiving a first-time going-concern-modified audit opinion during the period 1994–97 and a matched sample of financially distressed firms receiving a clean audit opinion. Results indicate that auditor switching is positively associated with receipt of a going-concern-modified opinion. However, we find no empirical evidence that there is a self-fulfilling prophecy of increased probability of company failure following the issuance of a going-concern-modified opinion for the Australian companies in our study. Our analyses of lost audit fees indicate that auditors issuing first-time going-concern-modified audit opinions lost proportionately more fees by losing clients (through switching or company failure) than firms not issuing a going-concern-modified opinion to financially stressed clients.     

Auditor economic incentives and going-concern opinions in a limited litigious Continental European business environment: empirical evidence from Belgium

Theory predicts that auditor reporting behaviour may be influenced by the perceived consequences of disclosing going-concern uncertainty in the audit report (DeAngelo 1981, Watts and Zimmerman 1986). Krishnan and Krishnan (1996) and Louwers (1998) have addressed this issue empirically in a US context. The results of Krishnan and Krishnan (1996) suggested that one of the important factors in the auditor's opinion decision is the risk of litigation. The purpose of this study is to examine the relationship between auditor economic incentives and the propensity to issue going-concern opinions in a limited litigious business environment, Belgium. In spite of the low risk of litigation and the fact that most Belgian companies are privately held, various regulations have been put into effect to safeguard audit quality in Belgium. However, the results suggest that the auditor's going-concern opinion decision in Belgium is associated with factors relating to the perceived consequences of disclosing a going-concern opinion. Specifically, the results suggest that auditors in Belgium are significantly less likely to issue going-concern opinions to clients that pay higher audit fees, and when the audit firm has lost a relatively high proportion of its clients in the preceding year. The auditor's going-concern opinion does not appear to be significantly influenced by the length of the auditor-client relationship, year of the auditor engagement period, and auditor type. The results of this study are to some extent different from the study by Louwers (1998), in which none of the incentive variables related to the auditor's loss function was significant.     

Non-audit fees, institutional monitoring, and audit quality

We posit that the effect of non-audit fees on audit quality is conditional on the extent of institutional monitoring. We suggest that institutional investors have incentives and the ability to monitor financial reporting quality. Because of the reputation concerns and potential litigation exposure, auditors are likely to provide high audit quality, when they also provide non-audit services to clients, particularly when clients are subject to high institutional monitoring. We find evidence that, as non-audit fees increase, audit quality (measured by performance-adjusted discretionary current accruals and earnings-response coefficients) reduces only for clients with low institutional ownership but not for clients with high institutional ownership. Our results are robust after controlling for auditor industry specialization, firms’ operating volatility, size effect, and potential endogeneity between institutional ownership and audit quality.     

AUDITOR INDEPENDENCE,AUDIT QUALIFICATIONS AND THE PROVISION OF NON-AUDIT SERVICES: A NOTE

This paper presents the results of a study designed to investigate the question of whether there is the potential for an appearance of auditor independence impairment when higher levels of non-audit services are provided to audit clients. This question was investigated by analysing the audit reports for a sample of publicly listed companies over the period 1980 to 1989. The results of the analysis indicate that the auditors of companies not receiving an audit qualification of any type over the period derived a significantly higher proportion of their remuneration from non-audit services fees than the auditors of companies receiving at least one audit qualification. This result is driven by the non-Top 100 companies in the research sample. These findings could suggest that auditors are less likely to qualify a given company's financial statements when higher levels of non-audit services fees are derived. This could convey the view that the independence of the auditors of these companies may have been compromised.     

Audit Pricing of Shared Leadership

This study explores audit implications of shared leadership in client firms. Analyzing data from 2002 to 2013 of Korean listed companies, we find that auditors spend fewer audit hours and charge lower audit fees for clients with multiple CEOs. Additional tests reveal that the lower audit fees for co-CEO clients are likely attributable to reduced audit effort rather than to reduced hourly rates. We also document that firms with co-CEOs exhibit better-reporting quality than do firms with a solitary CEO. In sum, this article presents evidence that mutual monitoring via co-CEO appointments assures high-quality financial reporting of audit clients, and thus leads to reduced audit fees.     

Do Big-Four affiliates earn audit fee premiums in emerging markets?

The paper investigates whether Big-Four affiliated (B4A) firms earn audit premiums in an emerging economy context, using Bangladesh as a case. The joint determination of audit and non-audit service fees is also examined using a sample of 122 companies listed in the Dhaka Stock Exchange. Our findings reveal that although the B4A firms do not generally earn a fee premium in Bangladesh, they charge higher audit fees for clients not purchasing non-audit services. This suggests that the B4A firms may actually lower audit fees to attract non-audit services, and cross subsidizes audit fees through non-audit-services fees. The lack of a B4A premium implies that there is lack of quality audit in emerging markets. We also document that audit and non-audit service fees are jointly determined in Bangladesh. Thus, we provide evidence of joint determination of audit and non-audit service fees in an emerging economy context.     

Auditor–Provided Consultancy Services and their Associations with Audit Fees and Audit Opinions

This study examines the relationships between non–audit services fees (consultancy fees) paid to auditors and (1) audit fees, and (2) the occurrence of qualified audit opinions. The positive association between consultancy fees and audit fees is shown to be due to certain company specific events that generate a demand for consultancy services as well as requiring additional audit effort. Identified company specific events are mergers and acquisitions, new share issues, new accounting and information systems, new CEOs, and corporate restructurings. When these events are absent, there is no statistically significant relationship between audit fees and consultancy fees after controlling for company size. Companies that have relatively high consultancy fees are more likely to receive a clean audit opinion. This may be due to the non–audit work clearing up problem areas at the client company or it may be due to high consultancy fees impairing auditor independence. With the available data it is not possible to distinguish between these two reasons.     

The effects of corporate governance and audit and non-audit fees on IPO Value

This paper examines the effects of non-executive board members, audit committee composition and financial expertise, and fees paid to audit firms on the value of 375 UK initial public offerings (IPOs). Empirical findings show that underpricing decreases in audit fees whereas it increases in non-audit fees. A higher proportion of non-executive directors on the firm’s board and audit committees with a higher proportion of non-executive directors and financial accounting expertise of their members positively moderate the inter-relationships between underpricing and both audit and non-audit fees paid by companies going through an IPO. Further investigations using the adjusted price-to-book value as a proxy for firm value at IPO confirm our main findings that internal governance mechanisms may complement services provided by the auditors in terms of generating higher valuations. Controlling for the simultaneous determination of audit and non-audit fees, our results remain consistent.     

On the Relationship between Audit Tenure and Fees Paid to the Audit Firm and Audit Quality

Abstract

We investigate the impact of audit firm tenure, partner tenure, audit fees, fees for non-audit services and total fees on audit quality, as measured by discretionary accruals. Our sample consists of Spanish non-financial public companies for the years between 2006 and 2013. Results indicate that audit quality increases with audit firm tenure but decreases with partner tenure. Moreover, the level of fees paid to the audit firm seems to have a negative impact on audit quality, which is mainly driven by fees for audit services. In this regard, we do not observe any significant relationship between fees for non-audit services and audit quality. Our results also show that the negative relationship between either long partner tenures or high fees and audit quality does not occur when the tenure with the audit firm is long. Therefore, long audit firm tenures do not only seem to involve higher audit quality ‘per se’, but also moderate the negative effects of partner tenure and audit fees on audit quality. The results of this study, which are robust to several sensitivity checks, may be relevant for the current debate on auditor rotation and the joint provision of audit and non-audit services.     

Public Disclosure of Audit Fees and Bargaining Power between the Client and Auditor: Evidence from China

Before the public disclosure of audit fees was mandated, it was unlikely for an audit client to have accurate information about how much other companies were charged by their auditors. Public fee disclosure decreases the cost of auditees' access to audit fee information for the auditor's portfolio of clients and is thus likely to increase the relative bargaining power of auditees over auditors when they negotiate audit fees. Using both proprietary and public audit fee data before and after public fee disclosure was mandated in China, we provide evidence consistent with the preceding conjecture. We find that public fee disclosure reinforces the magnitude of audit fee decreases for overcharged clients and weakens auditors' ability to raise audit fees for undercharged clients. These findings suggest the existence of unintended consequences of public fee disclosure regulation, the original rationale of which was a concern about audit pricing practices that could undermine auditor independence.     

Audit Reporting of Big 4 Versus Non-Big 4 Auditors: The Case of Ex-Andersen Clients

This paper examines audit reporting of Big 4 auditors versus non-Big 4 auditors for ex-Andersen clients and other clients. It suggests that ex-Andersen clients are more risky than other clients and are able to exert more influence than other clients on non-Big 4 auditors because they are larger in size than other non-Big 4 auditees. In addition, Big 4 auditors are more risk-averse and able to withstand clients' pressure than non-Big 4 auditors. The results show that Big 4 auditors are more likely than non-Big 4 auditors to issue going-concern opinions to ex-Andersen clients or restrict the level of discretionary accruals of those clients compared with other clients. Further, ex-Andersen clients of Big 4 auditors would have had a lower likelihood of receiving going-concern opinions or higher levels of discretionary accruals had reporting practices for other clients been applied. Ex-Andersen clients of non-Big 4 auditors would have had a higher likelihood of going-concern opinions or lower levels of discretionary accruals. Hence, the suggestion to reduce the Big 4 concentration in the audit market by allowing non-Big 4 firms a larger market share should be viewed prudently. Overall, these results are consistent with the suggestion that litigation risk and client pressure are important factors in audit reporting.     

Non-audit Services and Auditor Independence: New Zealand Evidence

Abstract:  This paper examines evidence in New Zealand about whether auditors providing more non-audit services are less independent. Three sets of tests are used to address the issue. The first examines whether there is a relation between non-audit fees and audit fees, the second examines whether there is a relation between non-audit fees and audit report qualification or modification, and the third examines whether there is a relation between non-audit fees and stability of audit tenure. The results suggest a potential for the impairment of auditor independence in appearance when auditors provide non-audit services but no evidence of any impact on independence of mind.     

Perceived auditor independence and audit firm fees

Regulations requiring the disclosure of fees paid to an auditor for audit and non-audit services (NAS) respond to concerns that such payments are potentially detrimental to auditors' actual or perceived independence. Although empirical studies have failed to produce unequivocal evidence of detrimental effects on auditor independence, the actions of regulators, audit firms and companies are consistent with the belief that economic bonding generated by fees can impair perceived levels of auditor independence.

Using a sample of UK companies over a six year period to March 2006, we study perceived impairment of auditor independence by examining the relationship between levels of total relative fees (combined audit and NAS fees payable by a company to its auditor as a proportion of the audit firm's UK income) and market value. This paper's methodological innovation is its use of a valuation framework in this setting. A further contribution lies in dropping the assumption of linearity found in most prior empirical studies. We provide evidence that shareholders perceive a threat to auditor independence only at high total relative fee levels. At lower levels, total relative fees are positively related to company value. These results suggest that disclosure of NAS and audit fees are of relevance to investors, as is information about auditor income. Our results support the view that regulation by reference to the threshold at which total relative fees are perceived negatively is more consistent with investor preferences than prohibition of the supply of NAS by auditors to their audit clients.     

The pricing of initial audit engagements by big 4 and leading mid-tier auditors

The recent investigation of the UK audit market by the Competition Commission testifies to perennial regulatory concerns regarding increasing supplier concentration, big 4 dominance of large company audits and the capacity of mid-tier auditors to compete. Against this backdrop, this paper presents new evidence on whether there is competitive pricing for initial audit engagements by big 4 auditors relative to their next four largest mid-tier (mid 4) counterparts for the UK quoted and private corporate sectors. Based on data from FAME for 2007 and 2010, the evidence indicates that larger quoted companies switching between the big 4 benefit from substantial discounts, with smaller discounts attracted by clients switching to the mid 4. Coupled with evidence that fees for both audit and non-audit services recover in subsequent periods, and consistent with the theoretical framework, the paper concludes that big 4 discounting is a competitive outcome aimed at securing future economic rents. New evidence demonstrates that smaller clients switching to big 4 or mid 4 auditors do not benefit from low-balling.     

Non-GAAP earnings reporting following going-concern opinions

We examine non-GAAP earnings reporting following a going-concern audit opinion (GCO). Using a propensity score-matched sample, matching first-time going-concern issuing companies with firms in financial distress that did not receive a going-concern report, we find that the likelihood and frequency of non-GAAP earnings reporting are lower following GCOs. In additional analyses, we find the negative association between the announcement of GCOs and the likelihood and frequency of non-GAAP earnings reporting stronger when GCOs are issued by industry-specialist auditors and when GCOs are unexpected, but do not find litigation risk or managers' ability to affect the association. These results are consistent with a decrease in investor demand for non-GAAP earnings disclosures following GCOs.     

Strategic Auditor Behavior and Going-Concern Decisions

This paper analyzes a game-theoretic model in which a client can potentially avoid a going-concern opinion and its self-fulfilling prophecy by switching auditors. Incumbent auditors are less willing to express a going-concern opinion the more credible the client's threat of dismissal and the stronger the self-fulfilling prophecy effect. Similarly, the client is more willing to switch auditors the more likely it is that auditors' reporting judgments will differ and the stronger the self-fulfilling prophecy effect. Further, with greater noise in the auditor's forecast of client viability, the auditor tends to express fewer going-concern opinions.     

The effect of strategic and operating turnaround initiatives on audit reporting for distressed companies

Empirical research on the effect of turnaround initiatives on audit reporting is scant. This paper addresses this gap by examining audit reporting for distressed companies and its association with a broad array of strategic and operating turnaround initiatives. In particular, we study the association between business risk information and going-concern decisions for distressed clients. Using a sample of distressed firms in the US manufacturing industry, we find that both short-term cash flow potential as well as strategic growth and hence long-term cash flow potential are necessary for strategic turnaround initiatives to have a mitigating impact on the auditor’s going-concern decision. Strategic turnaround initiatives for which only one of these two conditions holds and operating turnaround initiatives appear to function as going-concern risk factors as they are associated with a higher likelihood that a going-concern opinion will be issued. We also find that specialist and non-specialist auditors assess the mitigating potential of some but not all turnaround initiatives differently. Overall, our results suggest that auditors’ strategic risk assessment (typically done in a business risk auditing context) is associated with the outcome of the audit process (the opinion).     

Audit fee lowballing: Determinants,recovery, and future audit quality

Prior research on the link between lowballing (LB) of audit fees and audit quality is inconclusive. Using more recent data and an innovative design, we define LB engagements as those where the audit fee discount is at least 30 percent. We consider three research questions to understand the possible link between LB and audit quality. First, we investigate whether the two variables that are often associated with auditor independence in the literature—non-audit fees and client importance—are related to LB. Second, we test whether lowballing auditors recoup initial audit fee discounts in the future period. Lastly, we investigate the relation between recovery of audit fees and future audit quality. We find that non-audit fees in the first year of engagement are negatively related to the propensity to LB. LB is significantly positively related to client importance for client firms switching from a non-Big N to another non-Big N auditor while the relation is insignificant for client firms switching from a Big N to another Big N auditor. The results of non-audit fees and client importance indicate that economic dependence does not motivate audit firms to lowball. Further, lowballing auditors tend to recoup their initial fee discounts in subsequent periods via increases in audit fees. Using multiple measures of audit quality, we do not find a significant relation between recovery of audit fees and future audit quality. Overall, contrary to regulators’ concerns, our results suggest that LB does not impair audit quality.     

Note on audit fee premiums to client size and industry specialization

This research note examines the impact of client size on the estimation of audit fee premiums in the Australian market for audit services. Previous research suggests that higher audit fees are expected for both larger clients and for industry specialization. We find that in the Australian market for audit services, the fee premium attributed to industry specialist audit firms is concentrated in the audit fees paid by the largest clients in each industry. One reason for higher fees paid by larger clients is the demand for additional audit services. We find higher fees for companies cross‐listed on US exchanges. We also find that fee premiums to auditors that are city‐industry leaders are strongly related to client size.