Do Audit Fees and Audit Hours Influence Credit Ratings?: A Comparative Analysis of Big4 vs Non-Big4

Abstract

We examine the relationship between credit ratings / changes and audit fees (hours) for Big4 and Non-Big4 firms. Audit fee (hours) may be considered as a default risk metric for credit ratings agencies. However, firms audited by Big4 are larger, better performing and operate with lower leverage compared to firms followed by Non-Big4. Therefore, the association between audit fee (hours) may be different for firms followed by Big4 and Non-Big4 audit firms. We find that there is a negative association between audit fees and credit ratings for firms followed by Big4 audit firms. However, we find an insignificant relation for firms followed by Non-Big4. We conjecture the different association due to the Big4 firms having more robust accounting procedures; Big4 firms must offer competitive audit fees because they are engaged in fierce competition with other Big4 firms. Moreover, Big4 and Non-Big4 firms have different relationships with their clients because Non-Big4 firms are more income dependent on their clients. Using a sample of 1,717 firm–year observations between 2002 and 2013, we establish a relation between audit fees in period t and credit ratings in period t+1, for firms followed by Big4 auditors. We do not find a significant relation for firms followed by Non-Nig4 firms, suggesting that credit ratings agencies perceive audit fee differently for Big4 and Non-Big4 firms. Client firms followed by Big4 auditors that experience a credit rating change in period t+1 pay lower audit fees in period t compared to firms that do not experience a credit rating change. Our additional analysis suggests a different association between firms audit fees and firm performance for firms that experience a credit rating increase and decrease. Firms that experience a credit ratings increase in period t+1 have strong performance and lower audit fees in period t. On the other hand, firms that experience a credit rating decrease have weak financial performance and negative audit fees compared to firms that do not experience a credit ratings change. Our results suggest that audit fees combined with financial performance influence a credit ratings agency' perception of default risk.