Examination of Audit Fee Premiums and Auditor Switching Pre and Post the Demise of Arthur Andersen and the Enactment of Sarbanes-Oxley Act

Abstract

In light of the dramatically changing audit environment, we re-examine audit fee premiums and the effect of auditor switching on audit fees along the timeline from 2000 to 2005. Using the treatment effects model, we find that before the demise of Andersen and the passage of SOX, there were no audit fee premiums but that there was a reverse trend afterward. Furthermore, we classify the audit firms into three segments: Big N, second-tier (Grant Thornton and BDO Seidman), and third-tier (others). Our findings show a selectivity bias between Big N and second-tier firms but no selectivity bias between second- and third-tier audit firms. In addition, we find that while Big 4 auditors do not charge fee premiums over second-tier auditors, second-tier auditors charge audit fee premiums over third-tier auditors. Consistent with prior studies, our results show a low-balling effect in 2002, but afterwards audit firms charge extra fees to the clients downward switching from Big 4 to non-Big 4 audit firms. While risk can partly explain extra fees charged to the downward switching clients in 2004, it cannot explain this phenomenon in other years.

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