International evidence on economic policy uncertainty and asymmetric adjustment of audit pricing: Big 4 versus non‐big 4 auditors

Published date01 May 2018
Date01 May 2018
DOIhttp://doi.org/10.1111/jbfa.12299
DOI: 10.1111/jbfa.12299
International evidence on economic policy
uncertainty and asymmetric adjustment of audit
pricing: Big 4 versus non-big 4 auditors
Min Zhang1Haoran Xu2Lijing Tong1Tingting Ye3
1Schoolof Business, Renmin University of China,
Beijing,China
2Schoolof Accountancy and China Internal
ControlResearch Center, Dongbei University of
Financeand Economics, Dalian, China
3Schoolof Accounting, Shanghai Lixin University
ofAccounting and Finance, Shanghai, China
Correspondence
HaoranXu, School of Accountancy and China
InternalControl Research Center, Dongbei
Universityof Finance and Economics, Dalian,
China.
Email:xhr_bushiwo@163.com
TingtingYe, School of Accounting, Shanghai Lixin
Universityof Accounting and Finance, Shanghai,
China.
Email:yetingting_lisa@163.com
Abstract
By investigating the association between economic policy uncer-
tainty and audit fees using data from eight countries, this study
examines whether and how Big 4 auditors reinforce their advan-
tages over non-Big 4 auditors through audit pricing. We find that
both Big 4 and non-Big 4 auditors reduce their audit fees when
economic policy uncertainty increases. However, while non-Big 4
auditors adjust audit pricing asymmetrically as economic policy
uncertainty changes, i.e., the magnitude of decline in audit fees when
economic policy uncertainty increases exceedsthe magnitude of rise
when economic policy uncertainty decreases, Big 4 auditors regulate
their audit pricing in a symmetric manner. Further analyses reveal
that: (1) the asymmetric pricing of non-Big 4 auditors mainly existsin
countries where Big 4 auditors havedominant market share, (2) Big 4
auditors provide higher-quality audits when economic policy uncer-
tainty increases and (3) many firms in better financial condition turn
to Big 4 auditors during uncertain years. Our findings suggest that
the symmetric audit pricing helps Big 4 auditors maintain a favorable
position in the audit market.
KEYWORDS
asymmetric adjustment of audit pricing, Big 4 and Non-Big 4 audi-
tors, economic policy uncertainty
1INTRODUCTION
In the past severaldecades, an essential feature of the global audit market has been the market dominance of the Big 41
auditors (Walker& Johnson, 1996). In most audit markets worldwide, concentrations of Big 4 auditors generally range
from 50 to 98 percent depending on the measure of market share used (Karim, 2010). In the US, 70.4 percent of firms
were audited by Big 4 auditors in 1999, and the number climbed to over 90 percent in 2009 (Beattie, Goodacre, &
Fearnley,2003; Boone, Khurana, & Raman, 2012). This high level of concentration has raisedthe concern of regulators.
As early as 2002, the Sarbanes-Oxley Act required the US Comptroller General to study the factors that had led to
1Weuse Big 4 as a generic term encompassing the Big 6, Big 5, and Big 4 to reflect the consolidation of these firms.
728 c
2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/jbfa JBus Fin Acc. 2018;45:728–756.
ZHANG ET AL.729
audit market concentration.This study was heightened by the concern that the dominant auditors would impede com-
petition in the audit market,thus further deteriorating audit quality. In 2010, the European Commission issued a green
paper and listed questions such as whether the audit market is competitive and whether audit market concentration
is harmful as critical topics of interest. Another example is that the former SEC Chairman, Christopher Cox,expressed
his concerns in a speech at the 2005 AICPANational Conference (Cox, 2005):
within the accounting profession and within the SEC, we are forced to ask ourselves: “Is this intense concen-
tration in the marketfor large public company auditing good for America?”
The regulators’ concerns have greatly sparked the interest of researchers, and a substantial amount of work has
been done to understand what contributes to the market power of Big 4 audit firms (Beattie et al., 2003; Doogar &
Easley,1998). However, most of the extant literature focuses on auditor quality attributes such as industry specializa-
tion, audit quality, and professional reputation (Craswell, Francis,& Taylor, 1995; Dunn & Mayhew,2004; Dutillieux,
Stokes, & Willekens, 2013; Khurana& Raman, 2004; Krishnamurthy, Zhou, & Zhou, 2006), and empirical evidence on
how Big 4 auditors reinforce their advantages over non-Big 4 auditors through audit pricing is limited. According to
Simunic (1980), price competition is a significant aspect of competition between Big 8 and non-Big 8 auditors, and such
competition prevails throughout the market for audits. Therefore, it is necessary to see whether and how Big 4 audi-
tors build their competitive edge through audit pricing. Concerning audit pricing, there is a vast literature examining
the determinants of audit fees, while most studies focus on internal factors such as client size, complexity,and inherent
risks (Ettredge, Fuerherm, & Li, 2014;Hay, Knechel, & Wong, 2006; O'Keefe, Simunic, & Stein, 1994). Little attention is
paid to studying how auditors adjust audit pricing with external environments. In particular,to the best of our knowl-
edge, there is no study investigating whether auditors adjust audit pricing in a symmetric manner when the external
environment changes.
Our study fills the gap in prior literature by examining how Big 4 and non-Big 4 auditors adjust audit pricing as
the external environment changes. Specifically, we investigate whether the upward adjustment of audit fees when
economic policy uncertainty decreases and the downward adjustment when economic policy uncertainty increases
are performed in a symmetric way.We use the economic policy uncertainty index (EPU index), constructed by Baker,
Bloom, and Davis(2013), to capture the fluctuation of external economic policy environments in time series. This index
is a weighted averageof three components, i.e. the news-based component, the expiring tax code component,2and the
forecaster disagreement component. The EPU index is a good measure to capture the overallexternal economic envi-
ronment, and has recently drawn the interest of many researchers with a wide range of applications (Francis,Hasan,
& Zhu, 2014; Gulen & Ion, 2015; Zhang, Han, Pan, & Huang, 2015). Taking advantage of the EPU index, we are able
to better identify the audit pricing pattern of Big 4 and non-Big 4 auditors as external economic policy uncertainty
changes.
Prior research finds that economic policy uncertainty has a depressing effect on corporate investments (Panousi&
Papanikolaou, 2012). Weargue that the decreased investments will slow economic growth and reinforce firms’ finan-
cial constraints. Therefore, auditors will reduce audit fees when economic policy uncertainty increases. Unlike in peri-
ods when economic policy becomes uncertain, firms are subject to less cost-cutting pressure as economic policy uncer-
taintydecreases. As a result, auditors are inclined to increase audit fees to compensate for the loss arising from reduced
audit fees in uncertain years. In the long term, the rise of audit fees when uncertainty decreases should be sufficient to
recover the reduced audit fees in uncertainty years. Otherwise, auditors will suffer from a loss in revenues, and their
competitiveness will be weakened.
However, when auditors increase audit fees, theyare at the risk of losing clients because price is one of the most
critical considerationswhen c lients change auditors. Weconjecture that compared with non-Big 4 auditors, Big 4 audi-
tors have stronger bargaining power and are more capable of increasing audit fees when uncertainty decreases. That
is, although both Big 4 and non-Big 4 auditors offer fees reductions in uncertain years, Big 4 auditors are better able to
recover these reduced audit fees when economic uncertainty deflates. The reasons for this difference are that firms’
2Thiscomponent is used only when calculating the EPU index of the US.

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