Who You Know Matters: Evidence of Fee Discounts for Clients with Well-Connected Audit Committees

Abstract

Referrals and recommendations from clients are important for audit firms to develop their client portfolios. Client audit committees are one source of those recommendations, particularly when audit committee members hold multiple audit committee memberships. In this study, we measure the connectedness of audit committees to potential audit clients and we examine the effect of this connectedness on audit fees. Based on negotiation theory and the social norm of reciprocity, we expect and find a negative association between an audit client’s connectedness and audit fees. Our results suggest that audit committee connections result in auditors offering first-year discounts of approximately 4.2 and 7.1 percent per connection for non-expert and expert auditors, respectively. We also provide evidence that first-year discounts are provided only to companies with well-connected audit committees and not to the population of audit clients generally. Finally, we find that auditors are able to leverage these audit committee connections into new clients.