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

• Published date: 01 November 2018
• Author: Martin W. Schönberger,Nicole V.S. Ratzinger‐Sakel
• Date: 01 November 2018
• DOI: http://doi.org/10.1111/ijau.12138

ORIGINAL ARTICLE

The impact of auditor brand name on auditor remuneration in a

large private client segment

Nicole V.S. Ratzinger‐Sakel

1

|Martin W. Schönberger

2

1

Institute of Auditing and Accounting,

University of Hamburg, Hamburg, Germany

2

Institute of Accounting and Auditing, Ulm

University, Ulm, Germany

Correspondence

Martin W. Schönberger, Ulm University,

Institute of Accounting and Auditing,

Helmholtzstrasse 22, Ulm, Germany.

Email: martin.w.schoenberger@gmail.com

The purpose of this study is to investigate the impact of auditor reputation and

nonaudit services on audit pricing in the context of large private audit clients.

Focusing on German large private clients, we use a low litigious audit environment

that allows us to investigate the role of auditor reputation as proxied by auditor type

for three auditor tiers. We find evidence for a Big 4 audit fee premium, suggesting the

pronounced role of auditor reputation even in a private client segment. However, this

premium is subject to the Big 4 auditor's role in the national audit market. Audit

pricing is also affected by nonaudit services, which add value to the audit engagement

for the client. Nonaudit fees further incentivize pricing strategies for audits of private

audit clients, particularly for Big 4 auditors, which indicates a joint effect of nonaudit

fees and auditor type on audit fees.

KEYWORDS

audit fees,audit market, auditor choice,auditor reputation, non‐auditservices, private clientsetting

1|INTRODUCTION

The main outcome of the audit is the audit report, which is a generic

template with a lack of client‐and auditor‐specific information.

1

The

conduct of the audit is highly regulated by law and professional guide-

lines, implying a high level of standardization. Thus, an acceptable level

of audit quality is generally ensured, whereas a more detailed assess-

ment of audit quality is not possible for the public and is highly limited

for the audit client. Therefore, the potential for visible product

differentiation is rather limited.

Auditor choice and auditor remuneration are determined between

the audit client and the auditor. Given the lack of perceivable

differences in audit quality, the assumption that Big 4 premiums are

attributed to higher actual audit quality provided by the Big 4

(Francis, 2004, 2011) appears rather questionable (Lawrence,

Minutti‐Meza, & Zhang, 2011; for a review, see Hay & Knechel,

2017). Instead, Big 4 audit fee premiums might be based on auditor

reputation acquired through the large market shares of the Big 4,

particularly in the market for listed audit clients. Audit research has

addressed Big 4 premiums predominantly for listed audit clients who

are regularly audited by the Big 4 audit firms due to their size and

complexity as well as the potential expectations of capital markets.

Owing to limited auditor choice in the listed client segment, an

investigation of audit pricing mechanisms may be biased. Thus, this

study focuses on the German large private (nonlisted) client setting

and thereby contributes to answering the call for further research into

the Big 4 audit fee premium in settings with limited prior evidence

(Hay & Knechel, 2017). The German market for large private audit

clients presents a sample of large entities that are potentially appropri-

ate audit clients for Big 4 auditors and that are still viable audit clients

for smaller audit firms. Therefore, an investigation of this sample

presents an opportunity to investigate audit pricing in terms of an

audit client's willingness to pay higher audit fees and an audit firm's

ability to charge higher fees based on auditor type as a proxy for

auditor reputation. Thus, we are able to analyze the impact of auditor

reputation in a setting in which the potential bias of limited auditor

choice is smaller.

Nonaudit services are client‐specific engagement components

that are predominantly demanded deliberately by the audit client from

their incumbent auditor. Using the incumbent auditor for such services

also reduces the client's transaction and searching costs for an alterna-

tive service provider. Hence, nonaudit services may increase the

perceived value of the audit engagement or of a certain auditor for

the audit client. Nonaudit services are also considered to be more cost

efficient and to provide higher rents for auditors, which may affect the

value of a specific audit client for the auditor. The range and scope of

Received: 28 October 2015 Revised: 30 April 2018 Accepted: 28 June 2018

DOI: 10.1111/ijau.12138

536 © 2018 John Wiley & Sons Ltd Int J Audit. 2018;22:536–553.wileyonlinelibrary.com/journal/ijau

supplied nonaudit services might also present an opportunity for

auditors to differentiate themselves from other auditors and auditor

tiers. Hence, the difference in the perceived value of the audit

engagement for the audit client due to the provision of nonaudit

services potentially affects audit pricing.

Finally, we are interested in whether the potential impact of

nonaudit fees on audit pricing varies for different auditor tiers. Thus,

we address the supply side of auditing, as auditors may differ in audit

pricing depending on the level of nonaudit fees they gain from an

audit client. On the one hand, Big 4 auditors, who predominantly audit

the majority of listed audit clients, might be particularly able to

strategically reduce audit fees for private audit clients with high

nonaudit fees. On the other hand, Big 4 auditors might be able to

differentiate the audit engagement more distinctively than other

auditors by providing a wider range of nonaudit services. In this way,

they may gain an audit fee premium from audit clients who are willing

to pay high nonaudit fees. Hence, the fees gained for nonaudit

services might affect audit pricing in a way that depends on the

auditor type inter alia due to the role private audit clients play in

the auditor's client portfolio.

The purpose of this study is to investigate the impact of auditor

reputation and nonaudit services on audit pricing in the context of

large private audit clients. Thus, we extend the prior literature on

private audit clients, which is particularly scarce for large private audit

clients. We further extend the typical Big 4/non‐Big 4 dichotomy by

also controlling for second‐tier audit networks to model auditor type,

and thus proxy for auditor reputation. Therefore, we provide a more

detailed analysis of the role of auditor reputation for auditor remuner-

ation in a setting where the impact of reputation is expected to be

limited. We further add to the understanding of auditor reputation

by controlling for the impact of individual audit firms on audit pricing.

Owing to the lack of (actual) product differentiation regarding audit

services, nonaudit services might increase the perceived value of the

audit engagement as well as the incumbent auditor for the client. In

this regard, we offer an alternative interpretation of the positive

association between audit and nonaudit fees. Our findings are

valuable for illustrating the inherent underlying attributes of the audit

and their implications on auditors and audit clients. Both auditor rep-

utation and the value nonaudit services add to the audit engagement

for audit clients might affect audit pricing. Hence, audit clients may

be willing to pay higher fees when the auditor provides more benefits

to them in the form of auditor reputation or via nonaudit services in

addition to the statutory audit. Finally, we address the auditor's

perspective by testing for the joint effect of nonaudit fees and auditor

type. In this regard, auditors might be willing to accept lower audit

fees from audit clients with a (potentially) high level of nonaudit fees.

By contrast, Big 4 auditors, in particular, might be able to differentiate

the audit engagement via extensive nonaudit services compared with

smaller auditors, who might not be able to provide nonaudit services

to the same extent. For audit clients who are willing to pay high

nonaudit fees, Big 4 auditors might, hence, be in a position to charge

higher audit fees. These associations may hardly be disentangled in

samples of listed audit clients where auditor choice is highly limited

by client characteristics; however, our findings generally may be

applied to listed audit market segments as well, and thus contribute

to the understanding of audit pricing. Auditor reputation may also

affect listed audit clients when determining their auditor choice, audit

pricing, and their demand for nonaudit services. In times of invasive

reform measures in the market for listed audit clients, the market for

private audit clients may become even more relevant, particularly

for large auditors.

We find evidence for a Big 4 audit fee premium of 8.7% (calcula-

tion: exp(0.083) −1 = 0.087) over second‐tier audit networks and

smaller audit networks and audit firms in the German large private

client segment. This finding does not support H1, which is based on

the audit market environment of the private audit client sample. This

result indicates that auditor reputation enables Big 4 auditors to

charge audit fee premiums even in a private client setting, where the

direct benefits of the audit and auditor reputation are expected to

be limited for the audit client. The second‐tier audit networks are

not able to realize a significant audit fee premium. To further analyze

the positive and significant association between auditor type and audit

fees, additional tests are performed. These tests indicate audit fee

premiums for two individual Big 4 firms, PwC and KPMG. As PwC

and KPMG are the leaders of the German audit market for listed audit

clients, this finding might reflect that a Big 4 audit firm's impact on

audit pricing depends on the auditor's role in the national audit market

(for listed and private audit clients). By contrast, EY cannot gain a sig-

nificant audit fee premium despite being the market leader in our

private client segment sample in terms of number of audit clients. This

finding indicates that private audit clients also differentiate to some

extent between Big 4 auditors and other auditor tiers regarding their

willingness to pay higher audit fees and, thus, that auditor reputation

affects audit pricing even in a private client setting. Supporting our

second hypothesis, we observe a positive and significant association

between nonaudit and audit fees. In our sample, this result may

indicate an increased valuation of the auditors' services in the

presence of extended nonaudit services. Finally, by analyzing the

interaction between Big 4 auditors and the level of nonaudit fees,

we find that Big 4 auditors reduce audit fees in cases of high nonaudit

fees, which provides evidence on pricing strategies by Big 4 audit

firms to continue audit engagements with audit clients with a high

potential for nonaudit services.

This paper is structured as follows. In Section 2 we describe the

German audit setting for private audit clients. Then, we provide a

short literature review regarding the Big 4 audit fee premium in

Section 3 before developing our hypotheses based successively on

auditor reputation, the role of non‐audit services for the audit client

and the role of non‐audit services for the auditor in Section 4. Section

5 then presents an illustration of the research methodology, including

the sample, the model specification, and descriptive statistics. The

regression results are then presented in Section 6, with a supplemen-

tary analysis and robustness tests. Finally, we address limitations in

Section 7 and we close with concluding remarks in Section 8.

2|SETTING

Germany is the largest national audit market in Europe (Le Vourc'h &

Morand, 2011). Consistent with European requirements, an audit is

RATZINGER‐SAKEL AND SCHÖNBERGER 537