The effects of client importance on the initial audit fee discount

Abstract

I examine whether client importance at each audit office affects audit pricing at the time of an initial audit engagement as well as continuing engagements. Based on a sample of US firms in 2004 to 2013, the post-Sarbanes-Oxley Act (post-SOX) periods, I find that clients pay audit fee premiums at an initial audit engagement year and that important clients discount these premiums. The findings imply that important clients discount the premium of an initial engagement by exercising relatively great bargaining power. Next, I test whether the effect of client importance on initial audit pricing is sensitive to 1) types of auditors and 2) macro economy conditions. I find that the negative impact of client importance on initial audit pricing is significant only for non-Big 4 auditors. The finding suggests that either small bargaining power or little legal and reputational risk make small auditors to yield the pressures from important clients. Second, I find that the negative impact of client importance on initial audit pricing is significant only for post-crisis period (2010-2013), neither pre-crisis nor crisis periods. The findings suggest that the downward fee pressure during the crisis period affects the relationship between client importance and initial audit fee and that the effect is prolonged after the crisis.