Audit fee lowballing: Determinants, recovery, and future audit quality
•Non-audit fees in the first year of audit engagements are negatively related to the propensity to lowball audit fees.•Lowballing is significantly positively related to client importance for firms switching from a non-Big N to another non-Big N auditor while the relation is insignificant for firms s...
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Published in: | Journal of accounting and public policy 2021-07, Vol.40 (4), p.106787, Article 106787 |
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Main Authors: | , , |
Format: | Article |
Language: | English |
Subjects: | |
Citations: | Items that this one cites Items that cite this one |
Online Access: | Get full text |
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Summary: | •Non-audit fees in the first year of audit engagements are negatively related to the propensity to lowball audit fees.•Lowballing is significantly positively related to client importance for firms switching from a non-Big N to another non-Big N auditor while the relation is insignificant for firms switching from a Big N to another Big N auditor.•Fee recovery in the subsequent years via increases in total fees and audit fees occurs significantly faster for lowballing auditors than non-lowballing auditors.•We find no evidence of fee recovery by lowballing auditors via increases in non-audit fees in the subsequent years.•Fee recovery does not impair 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. |
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ISSN: | 0278-4254 1873-2070 |
DOI: | 10.1016/j.jaccpubpol.2020.106787 |