Audit fee lowballing doesn’t pay off for public corporations

Companies that work with auditors who have more industry experience but charge more than competitors offering “lowball” auditing fees tend to save more money in the end, according to a recent study.

The study, co-authored by professors Birendra Mishra and Theodore Mock from UC Riverside’s School of Business, found that businesses that use auditors who specialize in the corporation’s industry see cost savings and gain a better view of their finances, increasing investor confidence, 

The researchers analyzed 32,000 audit engagements in India and found that audit partners with extensive industry experience perform higher-quality audits while also providing cost savings to clients in their initial engagements. The study referred to auditors as “partners” with their clients in the finance industry.

“Expertise matters. An experienced audit partner in your industry can navigate complexities more efficiently, saving costs while ensuring better quality,” said Mishra, a professor of accounting, in a statement. “Think of an audit partner like a skilled surgeon — the more experience they have, the quicker and more precise they are, and that efficiency translates to savings for clients.”

The research indicated companies should avoid auditors who “lowball” their fees to compensate for a lack of experience. These auditors may offer low prices during the first year but then increase their fees in subsequent years to make up for the earlier discounts. The companies then end up with higher costs and lower-quality audits.

“Audit partners with more industry experience don’t rely on low-balling,” Mishra stated. “Their efficiency allows them to offer competitive initial pricing without the need for large fee hikes later. Low-balling can compromise audit quality because the focus shifts to recovering costs rather than delivering a thorough and accurate audit.”

The professors defined audit fee lowballing as charging relatively lower audit fees at the start of an audit engagement and increasing fees subsequently to recover the initial lowballing cost. This practice, utilized to entice new clients, concerns regulators because of its potential consequences for audit quality. The study examined the relationship between audit partner industry experience and lowballing, and its implications for subsequent audit fees and audit quality. 

The results indicated that higher audit partner industry experience is associated with discounted fees but superior audit quality in the first year of the engagement, suggesting that more experienced auditors pass on cost savings from process efficiencies to their clients. 

The research relied on audit data from India, where regulations have long mandated the disclosure of lead auditors in financial reports. This data allowed the researchers to track the industry-specific experience of individual auditors.

“The Indian auditing standards are remarkably similar to those in the U.S., making the findings highly applicable internationally,” Mishra noted.

The team developed a metric they called “INDEXP_PTNR” to measure an auditor’s cumulative years of industry experience. The professors used statistical models to assess the impact of this experience on initial-year pricing, subsequent fee adjustments and audit quality.

Audit costs can range from hundreds of thousands of dollars to tens of millions of dollars, depending on the size and type of company, but good auditing can potentially boost a company’s value. 

“High-quality audits strengthen the link between earnings and stock prices, boosting investor confidence in your company,” Mishra stated.