Auditor Selection and Audit Pricing in Mergers and Acquisitions

• In Event: Continental Breakfast and Research & Education Forum
  In Roundtable Session: Table 13: Auditor Pricing Studies

Abstract

We study auditor selection and audit pricing in mergers and acquisitions (M&A). In the M&A setting, the merged firm has the option of selecting an incumbent-auditor, either from the acquirer or the target, or selecting an outside auditor. Thus, auditor selection and audit pricing can be modeled as an auction between an informed incumbent-auditor and an uninformed entrant-auditor. Because of the incumbent-auditor’s information advantage, the entrant-auditor needs to underprice the audit engagement so as to have a chance of winning the auditing engagement. At the equilibrium, the incumbent-auditor randomizes her bids over a range to maximize the profit, whereas the entrant-auditor always bids the lower bound in an attempt to win the bid with some probability. Since firms have been required to disclose fees paid to auditor since 2002, we empirically test the predictions from the auction model, using a sample of M&A firms between 2002 and 2009. As predicted, the entrant-auditors bid significantly lower audit fees so as to win the auditing engagement. We find that ten percent of our merged firms select outside entrants to be their new auditors. Interestingly, those merged firms who select outside entrants as their new auditors experience higher audit-fee growth subsequent to appointing the new auditors. The extant theoretical auditing literature has long predicted that auditors lowball their audit fees to win audit engagements. We empirically document that the lowballing of audit fees indeed exists in the M&A setting.

Authors

• Ning Zhang, Duke University

• Nan Zhou, Binghamton University, SUNY