Pricing Initial Audit Engagements: Empirical Evidence Following Public Disclosure of Audit Fees

Drawing on competing theories in the audit pricing literature, we use publicly disclosed data on audit fees following enactment of FRR No. 56 to investigate whether initial audits are discounted. Our findings suggest that auditors discount initial audit engagements in the first two years of audit engagements, with fee discounts fading to normal levels by the third year and that discounting occurs for both same-tier and upgrade (non-Big 5 to Big 5) auditor realignments. The finding of same-tier initial audit discounting is inconsistent with empirical evidence from Australian audit markets where audit fees are publicly disclosed and initial audits of same-tier realignments are not discounted (Craswell and Francis 1999). We also find the cross-sectional variance in initial audit discounting varies with changes in financial distress of clients, client size, as well as differences between auditor size, industry expertise, and technological efficiency of predecessor and successor auditors. The evidence suggests the pricing of initial audit engagements in U.S. audit markets when audit fees are publicly disclosed is more consistent with initial audit engagement pricing theory offered by DeAngelo (1981) and Kanodia and Mukherji (1994) than with the public disclosure argument in Dye (1991). Overall, our findings suggest that perceived auditor independence seems unaffected by public disclosure of audit fees.