Findings to Date

The accompanying sidebar summarizes the major findings emerging from studies that have focused on accountants' fees. It is important to note, however, that these represent broad generalizations--contradictory results do exist. The conditional nature of each of these conclusions is discussed in greater detail below.

Audit Fees Vary. Not surprisingly, researchers have found that much of the variability in audit fees is explained by client attributes associated with audit effort and audit risk. Across numerous regression- based studies, measures of client size, complexity, and industry are consistently reported as having explanatory power. Large diversified companies with extensive receivables and inventories, for example, pay higher fees. Companies in heavily regulated industries (utilities and financial institutions), on the other hand, incur lower audit costs. Some researchers have speculated that the regulatory presence in these industries functions somewhat like increased internal control, reducing the relative audit effort required to perform the audit and thereby lowering service fees.

A number of other client variables have been incorporated into audit fee models, but with varying degrees of success. In general, additional measures of auditor exposure to risk seem to be among those most often reported as significant factors in regression analyses. Companies that experience financial difficulties or ultimately receive qualified audit opinions, for instance, have been shown to pay more for their audits.

Big Six "Premiums." Not all fee variability is related to differences in client characteristics. Studies have consistently shown that Big Six auditors charge higher fees. Various possible reasons have been offered for this premium. Some researchers have speculated that larger firms may be able to provide a higher quality audit--or at least the perception of a higher quality audit. CPAs in smaller practices will be interested, but perhaps not surprised, to learn that despite many attempts, researchers have generally been unable to demonstrate with consistency any differences in quality between Big Six audits and those performed by other accounting firms.

To date, interpretations of this premium rely on parallels to brand-name value in the consumer goods industry and the private-label or store- brand phenomenon. Marketing research in that field suggests that rivals trying to counter brand-name loyalty may be able to compete on price. To the extent similar reasoning applies to the audit market, the lower fees charged by other, non-Big Six auditors would represent evidence of competitive pricing.

"Abnormal" Audit Profits. If audit prices are truly competitive, then regression results across numerous studies would be expected to show a fairly consistent relationship between audit fees and the factors that influence the cost of performing an audit. More to the point, if auditors were earning "abnormally" high or "excess" profits, research studies would likely be reporting large percentages of unexplained variability in audit fee regressions. However, this has generally not been the case. Instead, most researchers have been relatively successful in using regression analysis to model audit fees, leading them to conclude that audits are very competitively priced. In fact, audit, prices not only exhibit little evidence of being excessively high, they may actually be too low, as suggested by research using various measures of client risk.

Client-Risk Considerations. Despite the general association of audit fees with client-related risk factors observed across fee studies, there is still debate over whether these relationships are as strong as they should be. For example, researchers have often been unable to obtain statistically significant results for measures they believe are indicative of high-risk clients. Furthermore, some consistent research results in this area seem counter intuitive. The relatively lower fees paid by financial institutions is perhaps the best illustration of this phenomenon.

In particular, the explosive increase in auditor litigation arising from bank and thrift audits in recent years would suggest higher prices on these engagements. That is, auditors would be expected to charge these companies more to compensate for the greater risk inherent in depository financial institutions. Some observers view the evidence of relatively low audit fees in the financial sector as an indication auditors may have underestimated this risk.

Initial Fee Discounts. Equally troubling to some are low prices apparent in the new client market. Indeed, accountants who have been actively involved in promoting the growth of their practices will not be surprised to learn that researchers have found compelling evidence of an audit fee decrease for companies that switch auditors.

Specifically, the prices auditors charge their new audit clients are systematically lower than those paid by longstanding client companies. In other words, auditing firms do seem to engage in price-cutting behavior. In addition, the discount offered to new clients appears to persist for at least two to three years before fees begin to return to more normal levels.

Non-Audit Services Fee Effects. Unlike the fee discount documented in the price cutting studies, the most frequently observed result in this line of research is perhaps unexpected and somewhat puzzling. A number of researchers report that audit clients who also receive non-audit services from their auditors pay relatively higher audit fees. This finding has obviously raised a number of intriguing questions. It has often been assumed auditors experience economies or cost savings by performing joint services. If this is true, why would they charge clients that receive non-audit services more for their audits? Or from the client's perspective, why would a company willingly pay more for an audit when receiving additional services from the same firm? While answers to these questions are far from clear, further studies in this area offer several possible explanations.

First, some non-audit services have audit implications. Engagements involving systems design or modification, for instance, may create the need for additional audit effort. Similarly, non-audit clients may somehow differ from the general population of audit clients. Their dependence upon ancillary services may indicate a need for more auditing, as in the case of financially troubled companies seeking managerial assistance. Alternatively, higher audit costs might reflect the greater complexity of certain non-audit service clients such as the large diversified enterprises that require a wide range of professional services.

A relatively new line of research suggests that audit pricing for clients that also receive non-audit services may depend on whether the non-audit services are recurring (as is often the case for tax work, for example) or nonrecurring in nature. Analysis in this area indicates that competition for recurring engagements may help keep service fees low, while the lack of comparable competition for non-recurring services may allow auditors to charge somewhat higher prices.

Independence Concerns. For auditors who provide audit clients with non- audit services, the good news stemming from available studies is that they provide little indication of any widespread independence problems. Although research in this area is not yet well developed, the reasoning behind the recurring vs. nonrecurring distinction seems promising. In particular, competitive pressures may prevent firms from charging artificially high prices that might otherwise lead to financial dependence upon a client who routinely receives non-audit services. Thus, in the case of recurring non-audit services at least, concerns about impaired independence may be overstated. On those joint engagements, auditors would have little incentive to sacrifice their objectivity merely to retain a client paying minimal fees set by market forces.

Studies of the disclosures formerly required by the SEC under ASR 250, on the other hand, suggest that while auditor-provided non-audit service may not pose any actual independence problems, they may nevertheless create the perception of problems. Specifically, research in this area indicates fees for non-audit services systematically declined relative to audit fees over the ASR 250 disclosure period. This finding is consistent with the notion that clients voluntarily refrained from buying such services to avoid market penalties, such as a reduced stock price due to investor worries about impaired independence. It is also consistent with the accounting profession's opposition to the rule and its claims at the time that the mandatory disclosures had hurt business and practice growth.

Interpreting the Results

It is important to emphasize that all of these findings are best regarded as tentative due to inherent problems in performing research. In the case of fee studies, these difficulties involve three main issues:

* A lack of comparability across the body of research.

* The use of questionable theories and methodologies.

* An absence of data about auditors' costs.

These limitations prevent researchers from drawing definitive conclusions, as further explained below.

Comparability. No two pricing studies use the same companies or even the same populations, making comparison of results difficult. While regression analysis provides some control over differences in corporate characteristics, researchers rarely define underlying variables the same way. Thus, the value of the results reported is very much dependent upon the judgment of the person performing the research.

Theory and Methodology. Most fee research draws upon traditional economic theories that focus on the selling of products rather than services, the literature in the latter area being much less developed. Whether product-oriented theories can be properly applied to a service like auditing remains an open question. Furthermore, these theories typically adopt the perspective of the buyer. The market for public accounting services, however, is a complex blend of both demand and supply. Clients may choose auditors, but auditors also select clients. Moreover, even with the right theory, truly random samples of fee data are rarely available, and underlying statistical assumptions are often unavoidably violated.

Data. Perhaps the most serious problem with studies of accounting fees is the data itself. Across auditors and even within the same firm, billing practices may differ. As a result, how to interpret fee analysis is open to debate. In fact, since the real concerns behind the controversies surrounding auditor competition focus on the tension between performance and profitability, many question whether any inferences should be drawn from fee research at all. Without access to data on auditors' costs and realization rates, the researcher's ability to provide insights into these concerns may indeed be limited.

Implications and New Directions

Practitioners could provide invaluable assistance to researchers by allowing them access to internal client data on billing rates, staff hours, and realized fees. However, most accountants are reluctant to divulge this kind of proprietary information, even on a limited basis. While this concern is understandable, it may be needless; educators are normally very sensitive to matters of confidentiality. Also, with the profession currently facing so many challenges, practitioners may now find the possibility of forming a research partnership with academicians an idea worth exploring.

There is clearly a great deal researchers still do not know about the ways in which auditors price their services and the effects their pricing decisions have upon the marketplace. Among the important questions that remain unanswered are the following:

* What is the nature of the relationship between audit prices and perceptions of audit quality?

* Are the amounts auditors charge adequate to cover risk in an increasingly litigious environment?

* Do auditors earn "excess" profits by performing non-audit services for audit clients?

* How do auditors allocate fees on joint (audit and non-audit) engagements?

* In what ways do non-audit services influence a company's decision in selecting an auditor?

With the profession now being asked to take on even more responsibility for detecting errors, finding fraud, assessing internal control, etc., one obvious question arises: Can accountants afford to assume the increased risk associated with these expanded duties and are clients willing to pay for them? Practitioners would no doubt welcome insights into the costs and consequences of providing such services. If they look to the academic community, they will find many researchers eager to address these shared concerns.

ACCOUNTANTS' FEES: MAJOR RESEARCH FINDINGS

* The size of the audit fee is largely explained by client characteristics associated with audit effort and audit risk.

* Companies appear to be willing to pay a premium for audits performed by Big Six firms, while there is no distinguishable difference in quality.

* Auditors do not appear to earn "abnormally" high or "excess" profits on audit engagements.

* Auditors may not fully adjust audit fees to reflect underlying client risk.

* Auditors discount the fees they charge new audit clients.

* Clients who receive non-audit services from their auditors seem to pay higher audit fees.

* Auditor-provided non-audit services appear to have generated no independence problems, but the perception of problems may still linger.

Richard A. Turpen, PhD, CPA, is an assistant professor of accounting at the University of Alabama at Birmingham.