Effects of Initial Audit Fee Discounts on Audit Quality: Evidence from Germany

Abstract

We examine the presence and magnitude of initial audit engagement fee cutting and its potential effect on audit quality in Germany using a sample of 992 firm‐year observations from 2005 through 2011. Our results show systematic fee cutting for initial audit engagement years in Germany. Despite significant audit fee differences between initial and subsequent audit engagement years, we do not find differences in audit quality. Overall, our findings support prior empirical studies, suggesting that low‐balling is merely a natural response of auditors to competitive audit market conditions and does not necessarily impair auditor independence. In the wake of the on‐going discussion in the European Union regarding the control of appointment, remuneration, and duration of audit engagements to curb threats to auditor independence, our findings do not support the implementation of audit market price controls through governmental regulators.

The impact of auditor brand name on auditor remuneration in a large private client segment

“…In line with Dobler (), SWITCH is insignificant throughout all estimations, which may indicate that neither audit fee premiums nor audit fee discounts are prevalent in cases of a (rather unusual) switch in the sample. Overall, the R 2 of 58.53% indicates a lower fit than most international and German audit fee models for listed audit clients (e.g., Antle et al, ; Köhler et al, ; Krauss et al, ); however, it is slightly higher than Chaney et al’s () R 2 of 57%, but clearly below Clatworthy et al’s () R 2 of 78% for private firms. The variance inflation factors are clearly below 10, with a mean of 1.2, indicating no multicollinearity concerns in the multivariate setting.…”

“…A meta‐regression approach used by Hay and Knechel () showed that despite a publication bias that tends to overstate the Big 4 audit fee premium, such a premium is still regularly found, most likely in the nongovernmental sector and in US settings but not for private audit clients (“nonstandard entities”). Bigus and Zimmermann (), Köhler, Marten, Ratzinger‐Sakel, and Wagner (), and Fleischer and Goettsche () provided German evidence on a Big 4 audit fee premium, whereas Krauss, Quosigk, and Zülch () did not report a Big 4 audit fee premium in the market for listed audit clients in Germany. Joha and Günther () found significant Big 4 audit fee premiums for private and public audit clients.…”

“…However, earlier studies that report this association are particularly subject to methodological concerns (e.g., Barkess & Simnett, ; Firth, ; Palmrose, ; Simunic, ; for critical contributions and alternative explanations, Solomon, ; Firth, ; for evidence from the German audit market, Bigus & Zimmermann, ; Fleischer & Goettsche, ; for an overview, Hay, Knechel, & Wong, ). After adopting a two‐stage approach to account for potential endogeneity due to the joint determination of audit and nonaudit fees, the evidence of potential knowledge spillovers is less distinct; for example, for no effect see Abdel‐Khalik (), Whisenant, Sankaraguruswamy, and Raghunandan (), and Hay, Knechel, and Li (), and specifically for Germany, see Köhler and Ratzinger‐Sakel (); for a positive effect, see Antle, Gordon, Narayanamoorthy, and Zhou (); and for a negative effect, see Krishnan and Yu (), and specifically for Germany, see Krauss et al ().…”

Abnormal audit fees and future restatements: evidence from Tehran Stock Exchange

“…As the first assumption, Dye (1991) indicates that the client is able to exploit this bargaining power in order to capture the entire cost savings. Accordingly, the author assumes that low-balling practices disappear as a result of getting the auditor to lower the audit fees and accept zero quasi-rent (Ghosh and Lustgarten, 2006;Krauß et al, 2014). Ghosh and Lustgarten (2006) regard cost savings as a 'pie' that could be shared equally or non-equally between the auditor and client, depending on the level of bargaining power between the auditor (monopoly power) and client firm (monopsony power).…”

“…Ghosh and Lustgarten (2006) regard cost savings as a 'pie' that could be shared equally or non-equally between the auditor and client, depending on the level of bargaining power between the auditor (monopoly power) and client firm (monopsony power). Dye (1991) also assumes that mandatory disclosure regime of audit fees is likely to stimulate the quasi-rents because the clients have an incentive to pay quasi-rents to influence auditor decision making when they are not publicly disclosed for third parties (Krauß et al, 2014). Therefore, it is concluded that low-balling practices are not likely to happen under a mandatory disclosure regime of audit fees (Dye, 1991;Krauß et al, 2014).…”