Client importance and non-Big 5 auditors’ reporting decisions

In this paper, we examine the effect of the trade-off between economic dependence and reputation protection on the link between client size and the audit reporting decisions of non-Big 5 auditors. We find that non-Big 5 auditors, like Big 5 auditors, do not allow their larger clients greater leeway to manage earnings. In fact, there is some evidence that non-Big 5 auditors treat their larger clients more strictly. In addition, non-Big 5 auditors, like Big 5 auditors, are at least as likely to issue a going-concern report to their potentially financially distressed larger clients as they are to their otherwise smaller clients.     

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.     

Does size matter? The influence of large clients on office-level auditor reporting decisions

Large clients create an economic dependence that may cause auditors to compromise their independence and report favorably to retain valuable clients. Economic dependence is measured as a client's size relative to the size of the office that contracts for the audit and issues the audit report. We find no evidence economic dependence causes Big Five auditors to report more favorably for larger clients in their offices. However, larger clients also pose greater litigation risk, and we do find that Big 5 auditors report more conservatively for larger clients, suggesting that reputation protection dominates auditor behavior.     

Do supply shocks in the audit partner labor market affect auditor choice? Evidence from a quasi-natural experiment

We examine whether supply shocks in the audit partner labor market induce clients to switch audit partners. We argue that audit partners in their early careers (i.e., junior partners) charge low audit fees to attract clients, which induces client firms to switch from senior partners to junior partners when there are more junior partners available. Utilizing the Big4 localization policy, we find that Big4 clients are more likely to replace senior auditors with junior auditors to cut costs after the policy. Furthermore, the results are mainly driven by clients who are charged high fees. Our empirical evidence enriches the understanding of auditor choice determinants and informs the ongoing debates surrounding new regulations for Big4 firms in China.     

Auditor changes following big eight mergers with non-big eight audit firms

This paper examines the reaction of clients of “non-Big Eight” audit firms to mergers of their auditors with “Big Eight” firms. We postulate that a non-Big Eight audit firm's clients will retain a Big Eight acquirer following a merger if they benefit from the Big Eight firm's specialized services and/or reputation. Clients that do not have these economic incentives to retain the Big Eight firm are more likely to change to another non-Big Eight audit firm following the merger. Empirical tests of the characteristics of clients that remain with a Big Eight acquirer or change to another smaller auditor following an audit merger generally support our hypotheses.     

The endogenous relationship between audit-report type and business termination: evidence on private firms in a non-litigious environment

This study provides evidence on the relationship between audit-report type and subsequent business termination for private companies in a non-litigious environment. The results show that an endogenous relationship exists between bankruptcy and audit-report type, and between voluntary liquidation and audit-report type. A non-clean opinion is typically issued when firms face financial difficulties, which in turn become more severe after the receipt of a non-clean audit opinion. We find evidence that, even without a litigation deterrent in Belgium, financial performance has a similar impact on audit-report type as in litigious environments. We find that the self-fulfilling prophecy hypothesis holds for bankruptcy but not for voluntary liquidation. Our study also provides some evidence on audit reporting differences between Big 6 and non-Big 6 auditors in the Belgian audit market. When financial difficulties are obvious, as is the case when a company is about to go bankrupt, both Big 6 and non- Big 6 auditors are as competent and/or independent to assess and report going-concern problems. However, when financial difficulties are less apparent, as is the case for firms that voluntarily decide to liquidate, our results indicate that Big 6 auditors are more likely to issue a non-clean audit opinion than non-Big 6 auditors.     

Big Six auditors and audit quality: The Korean evidence

This study investigates the association between discretionary accruals and Big Six and non-Big Six auditors, and the direction of auditor change. We hypothesize that there is no significant difference in discretionary accruals between Big Six and non-Big Six clients when there is low incentive for auditors to provide high-quality audits, as in Korea.Upon examination of the discretionary accruals of firms listed on the Korean Stock Exchange from 1994 to 1998, we find there is no significant difference between the discretionary accruals of firms with Big Six and non-Big Six auditors. This holds true for firms that switch from non-Big Six to Big Six auditors and vice versa. These resources imply that there may be no difference in audit quality between Big Six and non-Big Six auditors in Korea. This is consistent with other studies in Korea, while inconsistent with the findings of previous studies on audit quality in other countries.     

Determinants and consequences of voluntary switches to Chinese auditors in Hong Kong

Hong Kong market regulators have permitted 12 large Chinese accounting firms to audit the financial statements of Chinese firms that cross list in Hong Kong (i.e., H-share firms) since 2010. This paper examines the characteristics of H-share firms that voluntarily replaced their Hong Kong (HK) auditors with Chinese auditors, and the market reaction to auditor switches following this policy. We find that 38 out of 147 H-share firms voluntarily switched to Chinese auditors during 2011–2013. Switching firms are larger in size and are less likely to use Big4; they also have less need for external financing, a longer cross listing history, and a lower percentage of foreign revenue. We also find that investors negatively react to the auditor switches from HK non-Big4 to China non-Big4, but do not react to the auditor switches from HK Big4 to China Big4. This suggests that investors perceived lower audit quality for China non-Big4.     

Strategic pricing by Big 4 audit firms in private client segments

We examine how Big 4 auditors compete for new private clients. We find evidence suggesting that Big 4 auditors offer fee discounts to attract non‐Big 4 private clients to experience attributes of their brand name audit services. We also find that to attract clients from competing Big 4 suppliers, Big 4 auditors target fee discounts at clients in industries where they are the market leader. Our results further indicate that the Big 4 industry leaders target fee discounts to fast‐growing clients and are able to charge these clients significant price fee increases in the second mandate period (after 3 years).     

An investigation of recent changes in going concern reporting decisions among Big N and non-Big N auditors

Corporate accounting failures and regulatory proceedings that led to the enactment of the Sarbanes–Oxley Act of 2002 increased the scrutiny of auditors. We investigate whether these events resulted in a change in auditor behavior with respect to going concern reporting. Generally speaking, we find that non-Big N auditors became more conservative while Big N auditors became more accurate. Specifically, non-Big N auditors issued more going concern opinions to both failing and non-failing clients post-2001, reducing their Type II misclassifications at the expense of increased Type I misclassifications. However, Big N auditors decreased their Type I misclassifications with no corresponding increase in Type II misclassifications. Thus, our findings suggest that increased auditor scrutiny resulted in performance improvements in the area of going concern reporting primarily for larger auditors. For smaller auditors, improved going concern accuracy for subsequently bankrupt clients came at the cost of more going concern opinions being issued to subsequently non-failing clients.     

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.     

Auditor choice and accruals patterns of cross-listed firms

We examine the association between auditor choice and the accruals patterns of Chinese listed firms that cross-list in Hong Kong. Our evidence suggests that the clients of Big 4 auditors report lower unsigned discretionary accruals relative to the clients of non-Big 4 auditors. Further, we find that cross-listed firms with non-Big 4 auditors are more likely to understate their earnings and experience larger reversals of accruals in the future than cross-listed firms with Big 4 auditors. These findings suggest that Big 4 auditors play a meaningful role in improving earnings quality for cross-listed firms, which helps to explain why cross-listed firms have higher earnings quality than their domestic counterparts, as documented in the previous literature.     

Information sharing between mutual funds and auditors

This paper examines whether there is information sharing between mutual funds and their auditors about the auditors’ other listed firm clients. Using data from the Chinese market, we find that mutual funds earn higher profits from trading in firms that share the same auditors. The effects are more pronounced when firms have a more opaque information environment and when the audit partners for the fund and the partners for the listed firm share school ties. The evidence is consistent with information flowing from auditors to mutual funds, providing mutual funds with an information advantage in firms that share the same auditors. Our findings are robust to the use of audit-firm mergers and acquisitions (M&As) as exogenous shocks and several other robustness checks. We further find that auditors benefit by charging higher audit fees for mutual fund clients and by improving their audit quality for listed firm clients. Our study provides evidence of bi-directional information sharing between two important market intermediaries.     

Does corporate social responsibility affect auditor-client contracting? Evidence from auditor selection and audit fees

We find that firms with higher CSR performance are more likely to choose Big N auditors and less likely to switch to non-Big N auditors, consistent with socially responsible firms demanding higher audit quality. Furthermore, we provide robust evidence that firms with higher CSR performance pay lower audit fees using both levels and changes models, suggesting that higher CSR performance reduces auditor engagement risk. Our analysis based on the difference-in-differences approach indicates that it is higher CSR performance that leads to lower audit fees, not vice versa. Overall, the results highlight the important role of CSR performance in auditor-client contracting.     

Is there a relation between audit fee cuts during the global financial crisis and banks’ financial reporting quality?

As a result of the global financial crisis (GFC), several audit clients were able to negotiate lower audit fees for the years 2008 and 2009. However, the PCAOB has expressed concern that lower audit fees might lead to lower audit effort and lower audit quality and financial reporting quality. This study examines the relation between audit fee cuts and banks’ financial reporting quality. Specifically, we focus on earnings management via loan loss provisions (LLP), the relation between current period LLP and future loan charge-offs, i.e., LLP validity, and the timely recognition of loan losses. For banks audited by Big 4 auditors, we find that income-increasing abnormal LLP are decreasing in audit fee cuts and LLP validity is increasing in audit fee cuts. For banks audited by non-Big 4 auditors, LLP validity is higher for banks that received a fee cut of more than 25% relative to other banks audited by non-Big 4 auditors. We do not observe an association between timely loan loss recognition and cuts in audit fees except for banks audited by non-Big 4 auditors and exempt from internal control audits where a fee cut of more than 25% is associated with less timely loan loss recognition. Overall, the findings suggest that Big 4 auditors constrained earnings management via LLP in banks that received cuts in audit fees. Our findings have important implications for regulators, investors, and others.     

Busy auditors,financial reporting timeliness and quality

We investigate whether audit partners with multiple clients are able to complete their audits in a timely fashion, an important but largely unexplored area of academic research. One view is that having multiple clients increases the knowledge and experience of the audit partner resulting in a more efficient and therefore, quicker audit. On the other hand, having multiple clients may over-burden an audit partner resulting in a slower audit process and longer completion times. We find that audit partners with multiple clients take longer to complete their annual audit. More importantly, we also find that companies with busy auditors who take longer to complete their audits also have poorer levels of financial reporting quality. Additionally, in terms of consequences for busy auditors, firms with lengthy audit report lag switched their auditors the next year suggesting that busy audit partners may lose clients if their workload is excessive and they are not able to maintain audit quality. Our results are robust to alternative measures for both audit report lag and audit partner busyness and a range of endogeneity tests. We also undertake simultaneous quantile regression to assess changes in audit report lag depending on the number of audit clients per partner where we find preliminary evidence of a knowledge spill-over effect. Consequently, our results have implications for companies, audit firms, regulators and other key stakeholders.     

Audit market concentration,audit fees,and audit quality: A cross-country analysis of complex audit clients

Regulators around the world are concerned about the potentially harmful effects of high audit market concentration on audit pricing and quality. However, results in the overall literature have failed to reach consensus on this issue. We contribute to this debate by arguing that the audit market is segmented and that concentration in the Big 4 segment of the market leads to higher audit pricing. Accordingly, our analyses use international data and focus on concentration within the Big 4 group of firms across countries. We find that audit fees are increasing in our concentration measure for clients where the barriers to entry by competing auditors are higher, as proxied by client size, international operations, and IFRS use. Finally, we find evidence that audit quality is decreasing in Big 4 market concentration for these types of engagements. This indicates a wealth transfer from shareholders to audit firms when auditor concentration is high because these complex clients are charged more, but receive audits that are of lower quality.     

Is the audit services market competitive following Arthur Andersen's collapse?

This study investigates whether audit markets remain competitive in the wake of Arthur Andersen's demise and merger with Ernst & Young to create the Big Four. We conduct the study estimating audit fee models using Australian audit market data from both 2000 and 2003 to determine whether there is any evidence of cartel pricing either before, or subsequent to, the merger. In both years, we find evidence of a Big N price premium when estimating an audit fee model across all clients, and when we estimate the model separately across large and small client market segments. This evidence is consistent with product differentiation by Big N auditors and competitive markets.     

Effects of audit partners on clients’ business risk disclosure

We empirically investigate audit engagement partners’ involvement in business risk disclosure. Specifically, we examine whether the quality of business risk disclosure is influenced by engagement partner tenure and knowledge. We also examine whether the effects of partner tenure and knowledge are similar for Big 4 audit firms and non-Big 4 firms. Since fiscal year 2003, listed companies in Japan have been required to disclose business risk information. Although the business risk information is not audited, auditors concerned about their audit quality may seek to influence clients’ business risk disclosure practices. Giving advice to management on the narrative business risk disclosure can contribute to improving the perceived value of the auditor’s services which can be a competitive advantage. Using a sample of Japanese listed companies from 2003 to 2010, we find that if the engagement partners’ tenure is shorter, a company discloses more business risk information and the disclosure is more detailed. Furthermore, companies with audit partners who have a larger number of client engagements disclose larger amounts of business risk information in more detail. However, the engagement partner effects are mitigated if they belong to a Big 4 firm.     

Barriers to entry to the big firm audit market: Evidence from market reaction to switches to second Tier audit firms in the post-sox period

The US Government Accountability Office (GAO) studied concentration in the audit market and found that the Big 4 firms continue to dominate the market for clients with revenue of more than $500 million while non-Big 4 firms have gained market share among clients with revenue of $500 million or less (GAO, 2008). The US Treasury Advisory Committee on the Auditing Profession has expressed concern about barriers to entry that might prevent a non-Big 4 firm from increasing its market share among large publicly-traded clients (Advisory Committee, 2008). One of these barriers may be the potential cost to shareholders if the stock market reacts negatively to the appointment of a non-Big 4 auditor (GAO, 2003). We examine whether the stock market reacts negatively when clients switch from a Big 4 to a non-Big 4, because a negative reaction might make such switching less likely to occur. We find that the market does not react more negatively when clients move from a Big 4 to a Second Tier auditing firm than when clients move from a Big 4 to another Big 4 firm. Our results suggest that a negative market reaction may not represent a significant barrier to entry among Second Tier auditing firms.