Audit Fee Discounting: Looking Beyond Initial-Year Audits

Abstract

Do auditors discount fees to attract new clients? In contrast to most of the prior literature, a recent paper by Barua, Lennox, and Raghunandan (2020) (hereafter, BLR) suggests they do not. BLR discover that audit fee disclosures are often incomplete in auditor-change years (i.e., initial-year audits) and contend that this issue has caused researchers to incorrectly conclude that fee discounting exists. We propose a simple approach for studying discounting that focuses on the years surrounding an auditor change rather than the change year itself. Our proposed method addresses the incomplete fee disclosure problem identified by BLR, while also side-stepping the issues of duplicated effort and start-up costs on initial-year audits. Using BLR’s dataset, we compare our approach with theirs and provide evidence that discounting does occur. Consistent with the “winner’s
curse” principle, we also show that discounts are associated with temporary impairments to audit quality, supporting regulator concerns that price-competition between auditors can sometimes impair audit quality.

Keywords: audit fee discounting, low-balling, audit risk assessment

JEL Classification: M42