Government Intervention, Audit Fees, and Audit Quality

• In Event: Audit Complexity, Audit Efficiency, and Audit Fees

Abstract

We examine the consequences of a government intervention on the audit market (market structure, audit fees and audit quality). In October 2009, Chinese government initiated a set of policies to limit the market power of Big4 audit firms and to foster the attractiveness of top local audit firms, explicitly requiring certain companies to give priority to the latter in their choice of auditors. We exploit this setting as a natural experiment to explore the consequences of the direct government intervention on audit market structure, audit fees, and audit quality. We first find that the market share of top local audit firms increases significantly after the intervention mainly at the expense of local small audit firms. Despite a stable market share of Big4 auditors, we document a significant drop in Big4 audit fee premium after the intervention. Further we find that the audit quality of both Big4 and top local auditors increases, while the audit quality of small local auditors does not change. Taken together, our study suggests that the government intervention favoring top local audit firms makes the top local auditors more likely to differentiate themselves from other small local auditors, allowing the top local auditors to charge higher fees while providing higher quality audits. Such intervention also helps constrain Big4 market power by enabling the top local auditors to better compete with Big4 auditors, forcing Big4 auditors to offer better “value of money” (i.e., decrease fee premium but offer better quality services).

Authors

• Zhongwei Huang, ESSEC Business School

• Thomas Jeanjean, ESSEC Business School

• Like Jiang, Essec Business School