Industry Expertise, Brand Reputation For Accounting Firms And Audit Fees

The audit fees of the international big four accounting firms (referred to as the "BIG4") has been expensive, but the BIG4has been occupying a higher market share in the audit market of China’s listed companies because of its high quality service and its high brand reputation. China’s accounting firms often expand its scale through the way of combination in order to compete with the BIG4. Overall, the total revenue of domestic accounting firms, but the per capital audit revenue is only a fraction of that of the BIG4. This phenomenon shows that the accounting firms do not become a leader simply by the expansion of the scale. The firms should have its distinctive features and they can develop the industry expertise to provide differentiated services in order to improve their competitiveness. The auditor industry expertise is reflected in the level of knowledge and experience in one or a few industries. The auditor with industry expertise can provide high quality services by finding errors and frauds of the financial report and reducing its earnings management level.It is recognized as important means to enhance the core competitiveness to develop the industry expertise and the brand reputation of accounting firms. The firms require a lot of upfront investment to develop industry expertise and brand reputation. Therefore, these firms need to charge higher audit fees to compensate the costs. The listed companies are able to recognize high quality services and they need to transmit high quality signals to the market by means of high quality auditors. Therefore, they are willing to pay higher fees. The study of Craswell has shown that the BIG8auditors acquired the audit premium of28%to39%in America because of its brand reputation, and the BIG8auditors with industry expertise acquired the audit premium of34%. Many scholars think that our audit market belongs to a buyer’s market, and the audit pricing initiative is firmly in the hands of the listed companies. When can China’s auditor get higher audit fees? In theory, whether the quality of a product can affect the price or not depends on the demand of quality for the product, and the higher a product’s quality is required, the more a consumer will pay, whose presupposition is that the product can be identified in the market. The audit service is so special that it is difficult for information users to directly observe audit process and to know the contract between auditors and companies. Therefore, they can not directly assess the quality of audit services, and the audit quality can only be measured through indirect variable, and auditor’s industry expertise and brand reputation are important variable. Whether will the listed company pay higher fees for the service provided by the auditor with industry expertise? If the firm has both industry expertise and brand reputation, such as the "BIG4" or "BIG10", whether will listed companies pay higher fees? These question needs to be verified through our further research.The paper analyzes how the industry expertise affects audit fees through SCP paradigm of industrial organization theory and Porter’s theory of competitive superiority. At the same time, the paper elaborates the mechanism of prompting the auditor to maintain audit quality through audit contract incompleteness, information asymmetry of audit market and auditor’s opportunism. The view of the paper is that the mechanism of reputation requirement, incentives and penalties after suffering losses prompts auditors to maintain high audit quality. Besides, the paper also considers the influence of China’s institutional background on China’s audit market and accounting firms, thus Ministry of Finance issued the new auditing standards in2006, and China Association of Certified Public Accountants issued opinions of "bigger and stronger" and CPA competence guidelines in2007. On this basis, the paper test the different influence of industry expertise on audit fees between the year2005-2007and the year2008-2010.The paper combines normative research with empirical research. Normative research presents theoretical expectations, which lays the foundation for subsequent empirical research. The hypothesis is put forward firstly in the empirical study, then the empirical test is done through data of China’s A-share listed companies from2005-2010.The paper is divided into six parts according to the research:Part I:The brief introduction of the paper. This part elaborates the background and significance of the study, and it emphasizes the importance of developing industry expertise to improve the competitiveness of accounting firms. At the same time, this part puts forward to research ideas and methods and points out the contribution of the paper.Part Ⅱ:The review of the literature. This part reviews the relevant literature about relationship between industry expertise, brand reputation and audit fees, and point out the research direction on the basis of the literature.Part Ⅲ:Institutional background and theoretical basis. This part elaborates the issuance of new auditing standards,"bigger and stronger" opinions and the issuance of CPA competence guidelines, which lay the foundation for subsequent comparative test. It elaborates the influence of industry expertise on audit fees through industrial organization theory and Porter’s competition theory, and it analyzes the influence of brand reputation on audit fees through audit contract incompleteness, information asymmetry of audit market and auditor’s opportunism.Part Ⅳ:Research design. This part proposes the hypothesis of the paper on the basis of above theory and defines relevant variables. Then the research model is established.Part Ⅴ:Empirical test. This part examines the effect of firm industry expertise, brand reputation on audit fees through the descriptive statistics, the correlation analysis and multiple regressions.Part Ⅵ:Conclusions and suggestions. This part mainly makes a summarization about the study result and put forward relevant suggestions from two aspects of accounting firms and regulators.The paper argues that information asymmetry is prevalent in the market and it is especially serious in the audit market because of the particularity of audit services. Information users can not directly observe the process of audit services and evaluate its quality. The results of audit services are standardized reports, which can not reflect the level of audit quality, In theory, information users can employ their auditors to identify the audit services again, but it is not workable in practice. When accounting firms are aware of the situation, they will take the initiative to provide high quality services to build their own brand reputation to distinguish themselves from other accounting firms. When consumers can not directly evaluate the quality of the product, the brand name will have a lot of value. The size of accounting firms largely determines the quality of firms, and produces the brand reputation. Large-scale firms have excellent human and material resources, and have a high market share, which make firms maintain high independence and not succumb to the pressure of listed companies. The international "BIG4" have developed centuries ago, and its brand reputation has been recognized by most countries in the world. China’s "BIG10" has developed rapidly in recent years, and has a high brand reputation in our country. The empirical study finds that the "BIG4" and "BIG10" acquire higher audit fees than other firms because of its brand reputation, thus the accounting firms with brand reputation can acquire audit fees premium. The accounting firms with industry expertise have access to relevant industry knowledge, expertise and experience because of its industry specialized investment and occupy a high market share in the relevant. industry, which finally creates economies of scale, improve audit efficiency and reduce audit costs. Firms can use low cost strategy to transfer the savings of audit costs to listed companies, which make firms gain a competitive advantage in price. On the other side, accounting firms need to invest a lot of industry specialized resources to develop their industry expertise, such as personnel training and specialized equipment and so on. At the same time, these accounting firms need to take the risk of failure and therefore require higher audit fees in return. The empirical study finds that the "non-BIG4and non-BIG10" and "BIG10" with industry expertise gain audit fees premium. It shows that economies of scale generated by industry expertise have little effect on audit fees. Therefore, accounting firms with industry expertise can gain audit fees premium. Besides, the paper also considers the influence of issuance of new audit standards,"bigger and stronger" opinions and CPA competence guidelines on the audit fees. The empirical study finds that firms’industry expertise has greater impact on audit fees, which shows that the new audit standards and relevant guidelines improve the level of industry expertise and lead to a higher audit premium.The contribution of this paper reflects in the following. Past literature only study one aspect of industry expertise and brand reputation individually. When a firm has both industry expertise and brand reputation, it is easy to confuse which aspect lead to audit premium. The paper will separate brand reputation out of industry expertise, and individually examines their impact on the audit premium. Besides, we consider the influence on industry expertise and scale because of issuing the new audit standards and "bigger and stronger" strategy. On this basis, the paper test the different influence of industry expertise on audit fees between the year2005-2007and the year2008-2010.