Long-Term Shifts in the Audit Market: Higher BIG-4 Fees are Associated with Greater Client Retention

• In Event: Continental Breakfast & Research and Education Forum
  In Paper Session: Table 4: Audit Fees

Abstract

Managers have to assess cost-benefit trade-offs in trying to decide whether to hire a BIG-4 (KPMG, PWC, D&T, E&Y) auditor as opposed to an NB-4 (Non BIG-4) auditor. Audit fees (costs) are readily available but the benefits of hiring a BIG-4 auditor are difficult to categorize and mostly unobservable. We assess these tradeoffs indirectly by comparing the fee and market share shifts as a consequence of the enactment of the Sarbanes-Oxley Act (SOX) and the collapse of Arthur Andersen (AA). These two events acted as a shock to the structure of the audit market leading, as documented in prior studies, to significant increases in audit fees as well as a reduction in the market share of BIG-4 auditors. We establish that these shifts are negatively correlated, that is, a higher increase of audit fees by BIG-4 auditors relative to NB-4 auditors results in a lower likelihood of switching to an NB-4. We interpret this result both through a discussion of the provisions of SOX and by solving for an equilibrium in a formal auditor-choice model.

Authors

• Hua Xin, University of Louisville

• Bharat Sarath, Rutgers University - Newark