Empirical Evidence on the Implicit Determinants of Compensation in Big 4 Audit Partnerships

TLDR

The study examines how Big 4 audit partners’ compensation is linked to firm, partner, and client characteristics in Sweden. The authors analyze tax and financial data of partners and clients to identify variation in implicit determinants of compensation across the Big 4. Compensation rises with larger or publicly traded client bases, industry specialization, and client acquisition, is more responsive to performance incentives as partners advance, and falls when audit failures occur.

Abstract

ABSTRACT This study investigates the implicit financial incentives of individual Big 4 audit partners by examining the association between a partner's compensation and characteristics of the audit firm, audit partner, and individual partner clientele for Big 4 firms in Sweden. Using tax and financial data for individual audit partners and clients, our empirical findings indicate that there is significant variation in the implicit determinants that are associated with compensation across the Big 4. We find that audit partners’ compensation is positively associated with the size of their clientele or the number of publicly traded clients, both of which represent revenue‐generating opportunities. Similarly, compensation and developing an industry specialization are positively related. In three firms, gaining clients is clearly related to an increase in compensation, while losing a client is associated with a reduction in partner income in only one firm. We find that audit partner income is more sensitive to performance‐related incentives, such as attracting new clients, as partners progress in their career. Finally, we find evidence that audit failures, proxied by reporting errors related to issuing a going concern opinion, are associated with lower compensation. These results should be of interest to the auditing profession, audit firms, and regulators when they consider the effects of implicit incentives of partner compensation on audit quality.