Trends in Audit Fees: Big-4 “Cherry Picking” or Non Big-4 Market Power?

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 1: Determinants of Audit Fees

Abstract

We analyze trends in audit fees charged by the BIG-4 audit firms (KPMG, PWC, D&T, E&Y) in
the period 2001-2010. Audit fees changed radically over this period due to the enactment of the Sarbanes-Oxley Act (SOX). In addition, one of the major audit firms, Arthur-Andersen (AA)
was driven into bankruptcy. SOX increased the regulatory requirements on the audit process and
the demise of Arthur Andersen increased the oligopolistic power of the BIG-4. Together, these
factors can be expected to lead to “cherry picking” by the BIG-4 where they audit a smaller base of more lucrative clients. In contrast, SOX also strengthened internal control within firms
increasing overall audit quality and mitigating “adverse selection” concerns with regard to the
accuracy of financial reports. This factor may be expected to empower non Big-4 auditors leading to smaller market shares and lower fees for Big-4 auditors. Our main goal in this paper is
to establish that both “cherry picking” by the Big-4 and empowerment of non-BIG-4 may be
detected in the long-term changes in fees and market share over the period 2001-2010. We also
examine whether the collapse of AA had a detectible effect on industry structure in addition to the SOX effect. We examine these issues by analyzing the correlation between fee changes and market share changes across size deciles and industries.

Author

• Hua Xin, Rutgers, The State University of New Jersey, Newark