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Abstract:

This study empirically examines the impact of mandatory audit fee disclosure on price competition in the audit market. We expect fiercer price competition between auditors after the public disclosure of audit fees because transparency about audit fee information is likely to increase client bargaining power and/or decrease the incumbent auditor’s bargaining power. Using a dataset including both pre- and post-disclosure audit fees we find that during a period from three years before and three years after mandatory disclosure, audit fees generally increase. However as from the year where audit fee disclosure is mandatory overcharged (undercharged) clients experience a downward (upward) fee adjustment. In addition, undercharged clients are able to mitigate the upward fee adjustment if they have higher bargaining power and/or have an auditor who faces stronger competitive pressure, i.e. lower auditor bargaining power. These effects in favor of the under- and overcharged clients are largest in the initial disclosure year suggesting anticipatory price adjusting behavior by audit firms. Additional analysis suggests that - irrespective of client and auditor bargaining power - as from disclosure onwards overcharged clients are better off switching auditors to obtain a more favorable fee, whereas undercharged clients are better off reappointing their auditor.