Fair value hierarchy, bargaining power, and audit pricing across audit firms’ client portfolios

Abstract

AbstractThis study explores how the presence of Level 2 and/or 3 fair value assets (FVA_23) influences audit pricing across small and large clients for Big‐4 and non‐Big‐4 audit firms. Through analysis of 7918 firm‐year observations, we investigate whether companies with FVA_23 incur higher audit fees than companies without FVA_23 and the differences between how Big‐4 and non‐Big‐4 firms price risk for large and small companies. Our theoretical basis is product differentiation and economic importance, which suggest competing influences on audit fees based on firm and company size. We are the first to analyze the effect of FVA_23 on audit fees with the United States sample including all industries during a stabilized regulatory period, and we are the first to explore the effect of FVA_23 on audit pricing across small and large audit clients for Big‐4 and non‐Big‐4 firms. We find companies with FVA_23 incur higher audit fees than companies without FVA_23. More specifically, we find small and large companies realize different audit fees compared to companies of similar size without FVA_23. Additionally, Big‐4 and non‐Big‐4 firms price audits with FVA_23 differently than audits without FVA_23. Furthermore, Big‐4 and non‐Big‐4 audit pricing is influenced by FVA_23 differently based on company size.