The Effects of Advertising and Solicitation on Audit Fees

Abstract

Several leading academic and professional accountants suggest that the crisis in auditing over the past few years may have had its origin in deregulation. Deregulation allowed firms to advertise their services and solicit new clients, and it is argued that it encouraged accounting firms to become more commercial and less professional by cutting fees and reducing quality. In this paper, we look at this issue in New Zealand which has the unique distinction of having separated the two forms of deregulation, namely advertising and solicitation, by six years. This allows us to separately examine the effect of each form of market competition. We find that advertising is associated with increases in fees, not decreases, which suggests quality-based advertising and not price-based advertising. The Big 8 audit firms can afford to advertise more, and the evidence shows that they received larger increases in fees after advertising was deregulated. However, large companies have more bargaining power and fee increases were not as large for them. Solicitation appears to have increased competition and resulted in lower audit fees: The big audit firms reduced their fee premiums, and larger clients received greater fee reductions. These results suggest that to the extent market competition can undermine professionalism, that effect is most directly attributable to the ability to aggressively solicit new clients.

Keywords: auditing, audit fees, competition, deregulation, advertising, direct solicitation

JEL Classification: M49, M47, L84