Auditor specialization, perceived audit quality, and audit fees in the local government audit market

Prior governmental research implies a positive relation between auditor specialization and audit quality, but the effect of specialization on audit fees is mixed. However, no single governmental study investigates the effect of auditor specialization on both audit quality and audit fees. Also, prior studies focus on either large- or small audit firms and often employ indirect proxies for audit quality. We study the effects of auditor specialization on perceived audit quality and audit fees. Our data represent both Big 5 and smaller audit firms and include three market-based measures of specialization. We survey 241 Florida local government finance directors and find that specialization is positively associated with perceived audit quality but not with audit fees. We also find that Big 5 auditors, often used as a proxy for higher audit quality in prior research, are not uniformly associated with increased perceived audit quality but consistently charge higher audit fees. Our results confirm a relation between measures of audit firm specialization and audit quality and raise questions regarding audit firm size and audit quality in the municipal sector. Our findings suggest that engaging specialized auditors may be good policy for many local governments.     

Local creative culture and audit fees

This paper examines the association between local creative culture and audit fees. Using a large, unbalanced panel data of listed US firms between 2004 and 2018, we find evidence that firms headquartered in US counties with high creative culture tend to pay higher audit fees than firms headquartered in counties with low creative culture. We also find that such firms tend to have longer audit report lag and are subject to more shareholder litigation. Cross-sectional tests show that real earnings management, managerial risk-taking propensity, and external corporate governance environment moderate the positive association between creative culture and audit fees. The positive association between local creative culture and audit fees remains robust to controlling for endogeneity concerns. Our study contributes to the emerging literature on local creative culture by providing evidence that local creative culture encourages managers and employees to undertake risky initiatives, thereby increasing audit risks.     

Government ownership,audit firm size and audit pricing: Evidence from China

The present study provides empirical evidence on the impact of government ownership on audit pricing behaviour based on data from Chinese listed companies between 2001 and 2008. Our findings, having controlled for auditor choice, indicate that state-owned enterprises (SOEs) incur significantly lower audit fees than non-SOEs. The results also reveal a significant interaction between the type of SOE (i.e., owned by central vs. local government) and audit firm size, which also affects audit fees. More specifically, large auditors tend to charge the central-SOEs lower audit fees than local-SOEs (province, city and county), while small auditors charge central-SOEs higher fees than local-SOEs. We explore a political economy rationale from a supply-side perspective in explaining the results.     

Measuring audit quality of local governments in England and Wales

The purpose of this paper is to model and test the audit quality provided to local governments in England and Wales. A key question is: are there major differences in audit quality provided? The Audit Commission, a national public body under Parliament, regulates the audits. It sets audit standards, appoints the auditors, and (although each auditor and client local government set the specific audit fee for that client) it establishes a formula to determine standard audit fees. The Audit Commission also conducts an annual review of the audit quality provided by the selected auditors, as well as a survey of client satisfaction. The majority of audits are conducted by District Auditors (public sector employees of the Audit Commission). About a quarter of local governments are audited by one of six private sector auditors (including three of the Big 4). Actual results indicate that audit quality differences are associated with the number of governmental audit clients and local government type. Generally, there were modest quality differences by auditor category.     

The association between municipal disclosure practices and audit quality

This study examines the impact of two proxies for audit quality on a model of public sector disclosure for a sample of municipal governments. I argue that more complete disclosures enhance the reputation of an independent auditing firm and that independent auditors, seeking to maintain a reputation of higher quality, positively influence the level of financial disclosures appearing in their clients' financial statements.Specifically, a variable indicating the presence of a (then) Big Eight auditor and regression residuals from a model of audit fees were used as surrogates of audit quality. These were included in a model designed to explain variation in an index representing financial disclosures required under generally accepted accounting principles for local governments. The results provide evidence in support of the hypothesized relationship between audit quality and disclosure.     

Governance regulatory changes,International Financial Reporting Standards adoption,and New Zealand audit and non‐audit fees: empirical evidence

This study examines the association between overseas and New Zealand governance regulatory reforms and New Zealand companies’ audit and non‐audit fees. Our models use temporal and International Financial Reporting Standards (IFRS) indicator variables to relate the timing of the fee changes to the incidence of the overseas and local reforms. We find that audit fees increased in New Zealand over 2002–2006. Such increases associate reliably with the transition to and adoption of NZ IFRS and not with earlier overseas governance reforms. Our study also documents a decrease in non‐audit fees over the same period, but we find no IFRS effect for non‐audit fees.     

Costs and benefits of auditors' disclosure of critical audit matters: Initial evidence from the United States

In an effort to make audit reports more informative to financial statement users, the Public Company Accounting Oversight Board (PCAOB) requires an expanded audit report in which auditors are required to disclose critical audit matters (CAMs). The new standard (AS 3101) became effective for audits of financial statements of large accelerated filers for fiscal years ending on or after June 30, 2019. Using a sample of annual reports of large accelerated filers with and without CAM disclosures, we examine the costs and benefits of the mandatory disclosure of CAMs in auditors' reports. Our evidence suggests that compared to auditor reports reporting no CAMs, the presence of a single CAM disclosure in the auditor's report provides incremental information to equity investors without a significant increase in audit costs. However, using the benchmark of a single CAM disclosure, multiple CAMs in an auditor's report results in higher audit fees and longer audit delays.     

Money laundering and audit fees

We investigate the association between state-level money laundering sentences and audit fees in the US. Money laundering measures a broad category of offenses involving financial transactions using funds or monetary instruments gained through criminal activities and tax evasion. We find that firms headquartered in US states with high rates of money laundering sentences pay more audit fees. Our results suggest that auditors incorporate, as a fee premium, the higher risks involved when clients operate in those states. Our result remains robust to alternative specifications of money laundering proxies, and to the inclusion of a number of firm-level and state-level control variables. We also conduct two-stage least squares and propensity score matching analysis to mitigate the endogeneity problem that might arise from omitted variables, reverse causality, or model misspecification problems.     

Transaction costs and competition among audit firms in local markets

We develop a measure to capture an audit firm's competitive position in a local audit market based on the transaction costs of changing audit firms included in DeAngelo's (1981) multi-period audit pricing model. Our competition measure reflects the size difference between the largest audit firm in a market specified by client industry at the city level and the other audit firms operating in that market. We find that audit fees of a client decrease as this size difference increases. This result suggests that smaller audit firms charge lower audit fees because of their competitive disadvantage to the local largest firm.     

Corporate lobbying: Resource-seeking or rent-seeking? Evidence from audit fees

Theory and prior research suggest that corporate lobbying is a primary means that corporations use to influence government policies either for improving firm performance (i.e., strategic decisions) or for rent-seeking activities (i.e., agency costs) but the evidence between lobbying activities and auditor assessments of audit risk remains unclear. Our results show that lobbying firms are associated with higher audit risks and fees, consistent with the idea that lobbying is related to rent-seeking and higher agency costs. In cross-sectional analyses, we find that the positive association between lobbying and audit fees is weaker for firms with strong corporate governance. Further analysis shows that firm financial returns or low earnings quality mediate the relationship between lobbying and audit fees. The results suggest that practitioners, users of financial statements and regulators could benefit by recognizing that lobbying activities could signal managerial opportunistic behavior.     

An empirical analysis of audit fee price competition after the Korean 1999 Omnibus Cartel Repeal Act

This study examines the audit service market in Korea after the 1999 Omnibus Cartel Repeal Act to determine if increased competition has led to audit fee discounting. Until 19 December 2001, when the Korean government enacted The Financial Supervisory Regulations, researchers could not address questions related to price competition in the Korean audit market due to data limitations. The new regulations allow researchers to examine audit effort for the first time because both audit hours and audit fees are now recommended disclosures. We use audit fee data of Korean companies for the 6-year period 1999–2004, and find evidence that total audit fees paid have been increasing but audit fees per hour have been decreasing. We also find that Big 5 auditing firms’ fees per hour are significantly lower than non-Big 5 auditing firms and are decreasing across time. These price pressures should be of concern to regulators and investors because prior research has demonstrated that price competition leads to discounting, which can result in unrealistically low audit fees and poor audit quality. Finally, as in previous research, we also find discounting of initial audit engagements in the Korean market.     

财政压力与地方政府融资平台的兴起

本文利用2004-2006年取消农业税的自然实验,使用1994—2009年的县级面板数据首次从实证上检验了财政压力导致地方政府融资平台成立这一假说。利用双重差分模型研究发现,取消农业税改革导致的财政冲击越大,县级地方政府在改革后设立融资平台的概率越高。这一发现在不同模型设定下保持稳健,并通过了基于改革前样本和利用其他税种收入变动构造的安慰剂检验。我们还排除了上述发现由扩权强县和财政省直管县等其他财政制度改革驱动的可能性。进一步的分析表明,面临更激烈的区域间竞争、初始财政禀赋较低的县更倾向于设立融资平台。本文丰富了关于财政压力对中国地方政府行为影响的研究,有助于更好地理解中国财政体制与金融制度之间复杂的关联性。     

Does information asymmetry predict audit fees?

This study investigates whether and how information asymmetry in the stock market affects the quantum of audit fees paid by auditees. It is based on a sample of 218 US publicly traded companies and adopts two well-established proxies for information asymmetry, namely bid-ask spread (BAS) and probability of informed trading (PIN). Empirical results provide evidence that, after controlling for all main audit fees determinants, information asymmetry is positively related to the quantum of audit fees paid. Overall, evidence supports the contention that less transparent companies convey higher audit risk, and therefore auditors require higher compensation.     

Voluntary formation of audit committees by large municipal governments

The Sarbanes–Oxley Act of 2002 requires that publicly-traded U.S. corporations have an audit committee in their internal control structure. In contrast to publicly-traded commercial firms, municipal governments are not required to form audit committees. Given that regulators believe it is a crucial aspect of internal control, we examine the extent to which city governments feature audit committees in the internal control structure. Based on a survey of financial managers from cities with populations greater than 100,000, we find that approximately 58% of the municipalities have such committees. Results indicate that larger and more financially viable cities are more likely to have audit committees. However, the form of municipal government and the quality of the local government’s financial reporting and audit processes are not significant determinants of the presence of an audit committee.     

The joint determination of audit fees, non-audit fees, and abnormal accruals

Prior research has estimated piece-meal the determinants of audit fees, non-audit fees and abnormal accruals. Intuition, informal analysis, and a variety of theories suggest that audit fees, non-audit fees, and abnormal accruals are jointly determined. We address this endogeneity issue by modeling the confluence of audit fees, fees for non-audit services and abnormal accruals in a system of simultaneous equations. Our joint estimation provides a starting point to look simultaneously at several competing theories. Using audit and non-audit fee data from the UK for 1994–2000, we find evidence consistent with knowledge spillovers (or economies of scope) from auditing to non-audit services and from non-audit services to auditing. While knowledge spillovers from non-audit services to auditing have been found in prior research [e.g. see Simunic, 1984], the presence of knowledge spillovers from auditing to non-audit services is a new result. Contrary to recent results in Ferguson et al. (2000) and Frankel et al. (2002), we do not find support for the assertion that fees for non-audit services increase abnormal accruals. In fact, contrary to the results in Ashbaugh et al. (2003) and Chung and Kallapur (2003), we find that non-audit fees decrease abnormal accruals, which we attribute to the productive effects of non-audit services. We also find evidence that audit fees increase abnormal accruals, consistent with behavioral theories of unconscious influence or bias in the auditor-client relation. The findings are robust to tests with US data. JEL Classification C30 · M40 · M41 · M49     

Size effects and audit pricing: Evidence from Germany

Previous research into audit pricing has focused on the US and Australasian markets. This study aims to elaborate on the role played by various size effects on audit pricing using data from the German market.As previous research has shown, audit firms that provide additional non-audit services are able to charge higher fees for auditing. By contrast, our results show that only Big 4 auditors can earn an audit fee premium by providing non-audit services.Our findings also show that the Big 4 premium shown by previous German research is strongly affected by the premium for overall market leadership. Furthermore, we find that the influence of risk variables such as leverage or past losses is significant only for small auditees, while for large auditees size is the determining factor.Finally, this study proposes that using the logarithm of the number of employees is a better proxy for company size than is the more commonly used logarithm of total assets because it is more constant over time and does not bear the risk of interdependencies with other financial statement-based variables. Therefore, its further use in audit pricing research is strongly recommended.     

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.     

Fair value and audit fees

This paper investigates the effect of fair value reporting and its attributes on audit fees. We use as our primary sample the European real estate industry around mandatory IFRS adoption (under which reporting of property fair values becomes compulsory), due to its unique operating and reporting characteristics. We document lower audit fees for firms reporting property assets at fair value relative to those employing depreciated cost—a difference that appears driven, in part, by impairment tests that occur only under depreciated cost. We further find that audit fees are decreasing in firms’ exposure to fair value and increasing both in the complexity of the fair value estimation and for recognition (versus only disclosure) of fair values. We corroborate our findings in two alternative settings: contrasting UK and US real estate firms and using UK investment trusts. Overall, the results suggest that fair values can lead to lower monitoring costs; however, any reductions in audit fees will vary with salient characteristics of the fair value reporting, including the difficulty to measure and the treatment within the financial statements.     

The impact of audit committee expertise on audit quality: Evidence from UK audit fees

Governance regulators currently place great emphasis on ensuring the presence of financial expertise on audit committees (Sarbanes-Oxley, 2002; UK Corporate Governance Code 2010–2016). Underlying this is a belief that greater expertise enhances the effectiveness of audit committees and, by extension, the quality of the external audit. This study investigates the impact of audit committee expertise on one measure of audit quality - audit fees paid by FTSE350 companies. Our analysis finds that audit committees possessing greater levels of financial expertise are associated with higher audit fees. When we segregate financial expertise between accounting and non-accounting, we find that the positive impact identified is driven by non-accounting expertise. Furthermore, when we separate FTSE100 and FTSE250 firms we find the impact of financial expertise is confined to FTSE250 firms. Our findings are important as they highlight the usefulness of segregating financial expertise between specialists and non-specialists, something which regulators in the UK and in the USA currently do not do. Our findings also highlight the potential value of audit committee expertise in smaller as opposed to larger listed firms, suggesting that the value of expertise to audit quality depends on the specific financial reporting challenges firms face.     

Non-audit services provided to audit clients,independence of mind and independence in appearance: latest evidence from large UK listed companies

This paper investigates whether the provision of non-audit services (NAS) to audit clients impairs auditor independence of mind and independence in appearance. The main contributions of this paper are in terms of its timeliness with respect to regulatory changes, the simultaneous examination of both forms of auditor independence and the methodological innovation whereby it uses a variable derived from the level of abnormal audit fees as a moderating variable in order to capture the direct impact of the NAS fee level on auditor independence as well as how its influence is moderated by the level of unexpected audit fees. Our results indicate that auditor independence of mind is compromised by the size of NAS fees, particularly for clients who pay below the level of expected audit fee. The stock market perceives that auditor independence is compromised by NAS fees but, at the same time, additional tests indicate that there are benefits that accrue from NAS and, in particular, the relation between return and non-discretionary net income is increasing in NAS fees. The balance of evidence suggests that the European Union is correct in undertaking some reform of the auditing market.