Audit Firm Mergers and Low Balling

Abstract

Motivation: This paper investigates whether audit firm mergers affect audit fee discounts in the initial year. The numerous mergers of audit firms in China’s capital market provide a quasi-natural experiment to investigate this issue.

Premise: The merger of audit firms can increase the firm size, thereby improving quasi-rents that are required by auditors. Therefore, we argue that the merger of audit firms will improve the auditor independence, thereby reducing the behavior of low balling.

Approach: We select samples from 43 cases of audit firm mergers that occurred between 2005 and 2013 in China and use ordinary least squares (OLS) regressions on 5,552 listed firm-years observations during the period from two years before to two years after the merger.

Results: We find audit firms would offer an initial fee discount to the clients, and the merging of audit firms can dramatically reduce the discounts on audit fees for new clients. We also show the treatment effect is more pronounced for non–state-owned enterprises (non-SOEs) and the merger between large audit firm and small ones.

Conclusion: The results suggest that low balling exists in China’s audit market. The merger of audit firms can curtail low balling, but only exists in non-SOEs. Moreover, the restraining effect of audit firm mergers on the low balling lies in the merger between large audit firms and small ones. Consistency: The findings in this paper can advance the understanding of the recent strategy raised by related regulators attempting to enhance audit quality.