Audit Pricing, Legal Liability Regimes, and Big 4 Premiums: Theory and Cross-Country Evidence

Posted: 31 May 2005 Last revised: 7 Sep 2012

See all articles by Jong-Hag Choi

Jong-Hag Choi

Seoul National University - College of Business Administration

Xiaohong Liu

The University of Hong Kong

Jeong-Bon Kim

City University of Hong Kong

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business

Date Written: December 16, 2009

Abstract

In this paper, we first develop a model in which national legal environments play a crucial role in determining auditor effort and audit fees. Our model predicts that: (1) audit fees increase monotonically with the strength or strictness of a country’s legal liability regime; (2) given a legal liability regime, Big 4 auditors charge higher audit fees than non-Big 4 auditors; and (3) the Big 4 fee premium decreases as a country’s legal regime shifts from a weak to a strong regime. We then test the model’s predictions using a large sample of audit clients from 15 countries with different legal regimes where audit fee data are publicly available. The results of our cross-country regressions strongly support the above three predictions, and are robust to a variety of sensitivity checks. Furthermore, we find that the effects of a legal regime on audit pricing and the Big 4 premium are more salient for the small client segment than for the large client segment. Overall, our regression results indicate that a country’s legal environment plays an important role in determining both audit fees and the fee spread between Big 4 and non-Big 4 auditors.

Keywords: Audit fee, Legal liability cost, Liability regime shift, Big 4 fee premium

JEL Classification: M40, M41, L84

Suggested Citation

Choi, Jong and Liu, Xiaohong and Kim, Jeong-Bon and Simunic, Dan A., Audit Pricing, Legal Liability Regimes, and Big 4 Premiums: Theory and Cross-Country Evidence (December 16, 2009). Contemporary Accounting Research, Vol. 25, No. 2, pp. 55-100, Available at SSRN: https://ssrn.com/abstract=730963

Jong Choi

Seoul National University - College of Business Administration ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

Xiaohong Liu

The University of Hong Kong ( email )

School of Business
The University of Hong Kong
Hong Kong

Jeong-Bon Kim

City University of Hong Kong ( email )

Department of Accountancy
83 Tat Chee Avenue
Kowloon Tong
Hong Kong
852-3442-7909 (Phone)

Dan A. Simunic (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
416-486-5361 (Phone)
416-486-6158 (Fax)

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