The Role of Auditee Profitability in Pricing New Audit Engagements

Abstract

This paper examines the role of auditee profitability in pricing new audit engagements. Changes in the auditing environment are noted that suggest that auditors are managing their practices differently than they did in prior years. Audit fees are examined to answer two questions: (1) whether CPA firms still discount fees for new engagements in the current audit environment; (2) whether such fee discounts are dependent upon auditee profitability. The results suggest that auditors still discount new engagements in the 1990s, but that they are less willing to offer discounts when auditees show losses in the year prior to the new audit engagement. Further, this result is stronger for companies that switch from non-Big 6 firms to Big 6 firms than it is for intra-Big 6 switches. These findings suggest that auditors are managing their exposure to audit risk by adjusting audit fees.