Managerial Auditing JournalLeaving a joint audit system: conditional fee reductionsClaus Holm Frank Thinggaard

Article information:To cite this document:Claus Holm Frank Thinggaard , (2014),"Leaving a joint audit system: conditional fee reductions",Managerial Auditing Journal, Vol. 29 Iss 2 pp. 131 - 152Permanent link to this document:http://dx.doi.org/10.1108/MAJ-05-2013-0862

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Leaving a joint audit system:conditional fee reductions

Claus Holm and Frank ThinggaardDepartment of Economics and Business, Aarhus University,

Aarhus, Denmark

Abstract

Purpose – The authors aim to exploit a natural experiment in which voluntary replace mandatoryjoint audits for Danish listed companies and analyse audit fee implications of using one or two auditfirms.

Design/methodology/approach – Regression analysis is used. The authors apply both a core auditfee determinants model and an audit fee change model and include interaction terms.

Findings – The authors find short-term fee reductions in companies switching to single audits, butonly where the former joint audit contained a dominant auditor. The authors argue that in thissituation bargaining power is more with the auditors than in an equally shared joint audit, and that theauditors’ incentives to offer an initial fee discount are bigger.

Research limitations/implications – The number of observations is constrained by the smallDanish capital market. Future research could take a more qualitative research approach, to examinewhether the use of a single audit firm rather than two has an effect on audit quality. The area calls forfurther theory development covering audit fee and audit quality in joint audit settings.

Practical implications – Companies should consider their relationship with their auditors beforedeciding to switch to single auditors. Fee discounts do not seem to reflect long-lasting efficiency gainson the part of the audit firm.

Originality/value – Denmark is the first country to leave a mandatory joint audit system, so this isthe first time that it is possible to study fee effects related to this.

Keywords Competition, Bargaining power, Audit fee, Fee change, Fee determinants, Joint audit,Fee discount

Paper type Research paper

1. IntroductionThe European Commission Green Paper (EC, 2010) raised the question whether jointaudits should be considered as a means to “dynamise” the audit market of largecorporations in Europe. The subsequent proposal for regulation of statutory audits ofpublic-interest entities (EC, 2011) suggests the use of joint audit as a complementarymechanism to mandatory audit firm rotation, i.e. suggesting that the maximum durationof the engagement could be extended from six to nine years (12 years in special cases) ifa joint audit is applied (EC, 2011, Section 3.3.3). Proposals of joint audits where two auditfirms are assigned to perform statutory audits of individual companies have often beenmet with fierce opposition. The typical arguments are that a joint audit inherentlyincreases costs for audit clients and its shareholders and increases bureaucracy(Neveling, 2006). A recent unpublished paper by Andre et al. (2013) suggests higheraudit fees in the mandatory joint audit system in France as compared to other countries(UK and Italy), when controlling for a number of engagement attributes including

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JEL classification – M42, L84

Managerial Auditing JournalVol. 29 No. 2, 2014

pp. 131-152q Emerald Group Publishing Limited

0268-6902DOI 10.1108/MAJ-05-2013-0862

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audit quality. A study by Zerni et al. (2012) finds that the choice of a voluntary joint auditin Sweden is associated with substantial increases in the fees paid by the client firms.However, together with other results – specifically that the employment of a joint auditis associated with a higher degree of earnings conservatism and smallerincome-increasing abnormal accruals – the authors interpret this finding assuggesting that higher audit quality is being priced in the market, and not thatinefficiencies make a joint audit more expensive. In our study, we exploit a naturalexperiment in Denmark in which a mandatory joint audit system for listed companieswas abolished and analyse whether audit fee discounts can be obtained from using asingle audit firm rather than two.

In Denmark, the joint audit requirement was introduced in the Danish Companies Actin 1930, and applied to all listed companies. The provision remained in force for 75 yearsuntil being abolished on January 1, 2005. In 1930, auditing in Denmark was primarily aone-man business (Thinggaard and Kiertzner, 2008, p. 144). The main argument forrequiring two independent auditors, therefore, was that it added an extra dimension oftrust to the audit – legislators simply feared that a single auditor would not be able to dothe job properly (Hasselager et al., 1997). In other words, the joint audit requirement wasintroduced as a response to concerns about audit quality. Nowadays, however, the auditquality of single audits is no longer questioned by the Danish authorities; the mainargument put forward by Danish legislators for abolishing the joint audit requirementwas that it represented an unnecessary financial burden on companies (Danish FinancialStatements Act, 2001, Basis for Conclusions § 135). Legislators pointed out that theavailability of large and worldwide auditor collaborations with the ability to cope withthe complex auditing tasks in listed companies, together with general developmentsper se, were a realistic alternative to the joint audit requirement.

We consider the unique Danish setting with a fixed point in time where companieswere allowed to switch to single audits. This enables us to analyse the audit fee effects inthe individual years following this and by using panel data and tracking the switchingyear of the companies, we are able to analyse whether fee differences between joint andsingle audits are long term or short term. The analysis speaks to the question of whethersingle audit fee discounts are related to competition or efficiency gains. Moreover, theunique Danish setting enables us to analyse whether the effect on audit fees of a switchfrom joint to single audits depends on how the audit work was shared before theabolition and hence the relative bargaining power between the client and the auditors.

The data used in this paper was collected for the whole population of Danishnon-financial companies listed on the Copenhagen Stock Exchange (CSE) at the time ofjoint audit abolition. In line with the stated expectations, we find support for feereductions for companies switching to single audits, but only in the first year of audit.We also find that the single auditor fee discount is conditional on how the audit workwas shared between the involved auditors before the abolition. Specifically, we onlyfind single auditor discounts in situations where the former joint audit was sharedunequally between a dominant and minority share auditor. In line with Dye (1991), weargue that in this situation bargaining power rests more with the auditors than in anequally shared joint audit, and hence that the auditors’ incentives to offer an initialfee discount are bigger in this situation. Together our results indicate that the singleaudit fee discounts are related to competition rather than reflecting permanentefficiency gains.

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The remaining part of the paper is organised as follows. In Section 2, we provide aliterature review and our hypothesis development. In Section 3, we describe the dataand research design. We provide descriptive statistics in Section 4. In Section 5, wepresent our results. In the final section we conclude, consider the limitations of thestudy and provide proposals for future research.

2. Literature review and hypothesis developmentWe first consider the arguments for a discount on audit fees by using a single auditor aftera switch from joint audits. According to anecdotal evidence, biddings over audit fees arecommon practice in “normal” years in Denmark, and indeed the unusual situation wherethe requirement for two auditors is abolished makes bidding even more likely, becauseclients are now suddenly in a very powerful situation in relation to its auditors. This createsa situation with some similarity to that of competition over an initial audit (DeAngelo,1981). The two audit firms might expect that audit fee discounts will be an argument for theclient to switch to a single audit firm and that their chance of being selected as the preferredsingle auditor is better if they offer a discount on the total audit. The two audit firms will bewilling to give the discounts because once they are chosen as the preferred auditor they willbe protected by the transaction costs of switching and thus are able to earn quasi rents.Another argument for finding audit fee discounts in longer periods when a company dropsone of its audit firms is related to efficiency gains. In a joint audit there is a general risk ofinefficiencies. There is, for instance, a risk that the efficiency of manuals and proceduresdisappears when an audit is shared. It could also be argued that some of the non-productiveoverheads of planning, supervision and review would be doubled when two auditors areinvolved. The possibility of an audit fee discount is also consistent with the cost argumentprovided by the Danish legislators, who claimed that the joint audit requirementrepresented an unnecessary financial burden on companies (Danish Financial StatementsAct, 2001, Basis for Conclusions § 135). This leads to the following hypothesis:

H1. There will be a negative relationship between audit fees and the use of singleaudits after a switch from joint audits.

However, arguments for finding fee discounts in both shorter and longer time periodsin the joint audit setting are possible. While De Angelo’s model is based on competitiveeffects from a (short term) battle over an initial audit (DeAngelo, 1981), there aredifferences between the one client-one auditor setting and a setting in which companiesare allowed to drop one of their audit firms, which may affect when and where singleauditor discounts can be found. Previous research outside the joint audit settingsuggest that under-pricing of auditing services in the initial audit engagementcontinues for three years and then disappears (e.g. Gregory and Collier, 1996 in the UK;Ettredge and Greenberg, 1990 and Simon and Francis, 1988 in the USA).

One argument for a long-term single auditor discount is that switching costsprobably are low if a client should decide to switch back to the newly dropped auditorin the first years after the initial decision. Hence, the chosen audit firm is less protectedby transaction costs in the first years after a switch. The chosen auditor is perhaps notable to earn quasi rents in the first years after a switch unless a switch back to thedropped audit firm is unlikely. Therefore, it is possible that audit fees will continue tobe lower in the first years after a switch, but as time goes by and the client and thedropped audit firm lose their familiarity with each other audit fees will gradually

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increase to normal levels where quasi rents can be earned. Single auditor discountsshould also be long lasting if efficiency gains can be obtained from using a single auditfirm rather than two. Moreover, if it is perceived that joint audits provide greaterinsurance value due to “deeper” and “more accessible” pockets in a jointly liablesituation then single auditors may have to offer permanent discounts on audit fees inorder to compensate for this. This provides another explanation for long-term singleaudit fee discounts.

In contrast, arguments for finding single auditor fee discounts only in the short termafter the decision to switch to a single audit can also be found. The regulation that theDanish two-auditor requirement would be abolished with effect for 2005 was passed in2001 and hence known by all parties here. Thinggaard and Kiertzner (2008) analyseaudit fees paid by listed companies on the Danish market in 2002, i.e. three years beforethe abolition of the audit requirement. Their results indicate that competitive effectsalready started to show up in audit fees in specific segments here. If competitive effectsdue to auditors jockeying for position as the single preferred auditor have reducedaudit fees during the three years before the actual abolition date, then there might onlybe a short-term additional single auditor discount left in the abolition year to close thedeal. This leads to the following hypothesis:

H2. There will only be a short-term negative relationship between audit fees andthe use of single audits after a switch from joint audits.

If H1 is supported, i.e. there are single audit discounts, then a rejection of H2 wouldindicate that single audit discounts are long lasting.

Next we query whether the particular competitive setting before the abolition ofjoint audits mitigates the expected fee discount of using single audits. Audit fee levelsmay depend on the bargaining power between the auditor and the client. In a jointaudit setting, bargaining power between the auditor and the client is likely related tohow the audit work was shared between the two joint audit firms, which again affectsthe level of competition. The two-auditor requirement in Denmark was silent as to howthe work should be shared and in practice the share of the audit job of each auditfirm varied considerably from very equally shared audits to audits where one of thetwo audit firms are very dominant. If costs of switching to a completely new auditfirm are significant, then the company has in effect created a duopoly in the case ofequal joint audits. In the dominant audit case, the company has given the auditor somemonopoly power, because there is only one seller who has already acquired specializedknowledge of the client. Thus, according to general price theory we would expect tofind higher fees in the monopoly power situation. The dominant joint auditor is in astrong position – she is already the company’s de facto single incumbent auditorand therefore likely already earning full quasi rents on the audit (Thinggaard andKiertzner, 2008). We expect this downward pressure on fees due to competitive pricingin the period leading up to the abolition to have an effect on audit fees in theyears after the abolition of the joint audit requirement. It is likely that audit fees thatare low due to competition before the abolition will continue to be lower in the firstyears after even if the choice of single or joint audits has an effect – the base level issimply lower.

Moreover, it is likely that the relative bargaining power between the audit firms andthe client, and hence the competitive situation before the abolition of the joint audit

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requirement also has an effect on the expected single auditor discount, i.e. it is likelythat a single auditor discount is conditional on the relative bargaining power betweenthe audit firms and the client (level of competition) before the company decided to use asingle audit firm. DeAngelo’s (1981) model rests on the implicit assumption that theincumbent auditor has all, or at least most, of the bargaining power in the auditor/clientrelationship (Dye, 1991). The model presumes that the incumbent auditor determinesthe prices at which subsequent audits will be conducted. If instead the bargainingpower rests with the clients, then they would insist auditors charge no more than theavoidable cost of the audit, in which case there would be no future rents. If auditorsanticipate this outcome, they would not reduce their price on initial audits (Ghosh andLustgarten, 2006; Craswell and Francis, 1999; Dye, 1991). When a joint audit with adominant audit firm is compared with a joint audit with two more equally sharingaudit firms, it is likely that bargaining power rests with the dominant audit firm in thefirst case and with the client in the last case. This implies that the dominant audit firmis in a better position to determine the prices at which subsequent audits will be pricedand hence more willing to give a large discount in order to be selected as the preferredsingle audit firm than when two equally sharing audit firms are involved in the jointaudit. Moreover, a dominant audit firm in a joint audit has more to lose than two moreequally sharing audit firms if the client decides to appoint another audit firm as singleauditor, which could induce the dominant audit firm to offer a larger initial discount towin the single auditor battle. The risk that a client should decide to switch back to thenewly dropped auditor is likely smaller in a joint audit with a dominant audit firmcompared to a more equally shared audit because the dropped auditor is typically theminority auditor. This means that the probability that the chosen single auditor will beable to earn quasi rents for a longer time is higher when the joint audit involved adominant auditor, implying that higher initial fee discounts can be offered. This leadsto the following hypothesis:

H3. The single auditor discount is significantly higher when the previous jointaudit involved a dominant auditor.

3. Data and research designThe Danish audit environmentThe Danish audit environment is characterized by a relatively large number of auditfirms and auditors. A count in The Central Business Register (CVR) shows that1,600 audit firms are registered in Denmark. In accordance with the EU directiveon statutory audits (EC, 2006) as implemented in national law, Danish auditors mustbe publicly qualified to audit a company with limited liability. The total number ofqualified auditors in Denmark is approximately 4,500, which is divided into2,100 state authorized public accountants and 2,400 registered accountants(Revisorkommissionen, 2011, p. 97). State authorized public accountants constitutethe upper tier with higher educational requirements and in listed companies at leastone audit firm must be state authorized. The demand for the services provided by theaudit firms can be related to a long tradition of mandatory audits for all limited liabilitycompanies. Denmark has approximately 232,000 limited liability companies; howeversince 2006 around 100,000 (very small) companies have been exempt from mandatoryaudits. In Denmark, an audit firm is appointed for one year but can be reappointed forconsecutive years.

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Data descriptionThe dataset is derived from the database Account Data, available at the CopenhagenBusiness School, which contains raw data from Danish companies’ financialstatements since 1983, and is supplemented with data from the Orbis database byBureau van Dijk, plus manually collected information from annual reports. Wecollected data corresponding to the full population of non-financial Danish companieslisted on the CSE (now Nasdaq OMX Nordic) facing the joint audit abolition. See Table Ifor variable definitions. We use Y0 to denote the first financial year when joint auditwas optional. For most companies this was 2005 (77 companies where the financialyear is the same as calendar year), but for the rest of the population, the first possible

Variable Definition

AuditFee Natural logarithm of total audit fees in euros paid to the signing auditorsOtherFee Natural logarithm of total consultancy fees in euros paid to the signing auditorsSingle A dummy variable with the value of one if the audit is conducted by a single

auditor, and zero if the audit is conducted as a joint auditBig4 A dummy variable with the value one if Big Four audit firms conduct all of the

audit (either as a single auditor or as joint auditors), that is if the signing audit firmis B4 or B4-B4, and zero otherwise

Dominance A dummy variable with the value of one if ratio between audit fee of the largest tothe smallest auditor in the last year of mandatory joint audit system (YB1) isabove median, and zero otherwise

Size Natural logarithm of total assets in eurosLeverage Ratio of debt-to-assetsLoss A dummy variable with a value of one if net income is negative, and zero

otherwiseComplexity Ratio of sum of inventories, debtors and internally generated intangible to assets

(complexity of substance)Subsidiaries Square root of the number of subsidiaries recorded for the company (technical

complexity)BusySeason A dummy variable with the value of one if the company uses the calendar year as

the financial year, and zero otherwiseMajorShareholder A dummy variable with the value of one if major shareholders hold more than

25 percent of direct total ownership, and zero otherwiseIFRS A dummy variable with the value of one if YB1 restatements in Y0 comparative

figures resulted in absolute change in total assets and zero otherwiseChgAuditFee The first difference change in audit fee between two successive years (that is YB1

to Y0, Y0 to YA1 and YA1 to YA2)ChgJtoSingle A dummy variable with the value of one if change from joint audit in year before

to single in current year, and zero otherwiseChgSize The first difference change in size between two successive yearsChgLeverage The first difference change in leverage between two successive yearsChgOtherFee The first difference change in other fees between two successive yearsChgComplexity The first difference change in complexity between two successive yearsChgSubsidiaries The first difference change in subsidiaries between two successive yearsLossNoLoss A dummy variable with the value of one when a client reports a loss for the prior

year but not for the current year, and zero otherwiseNoLossLoss A dummy variable with the value of one when a client reports a loss for the current

year but not for the prior year, and zero otherwiseChgIFRS A dummy variable with the value of one if IFRS adoption in Y0 resulted in YB1

restatements in Y0 comparative figures for total assets and zero otherwiseTable I.Variable definitions

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year for change was the financial year 2005/2006 (31 companies). We follow this cohortof 108 companies starting in Y0 providing an almost balanced panel dataset for threeconsecutive years. For the purpose of the fee change model, we also include datafrom the same companies in the year before the abolition here denoted YB1. Table IIshows the population and sample selection for our analyses. Due to missing companydata for the various models, the final number of firm-year observations is reduced to,respectively, 313 for the pooled fee levels model and 289 for the pooled fee changemodel. Whenever we use financial statement information from YB1, due care wastaken to base the information on the same (IFRS) accounting regulation as in thefollowing years. As we did not have access to any database with financial statementinformation before Y0, restated to IFRS, we had to collect this information manually forall companies from the comparative figures in the Y0 financial statements.

Research designIn order to study the possible fee implications, we apply both a core audit feedeterminants model, which has evolved from the seminal study by Simunic (1980) andan audit fee change model inspired by studies of initial audit engagements by Ettredgeand Greenberg (1990) and Ghosh and Lustgarten (2006). The purpose of using bothlevels and change models is to increase the validity of our findings by balancing theadvantages and limitations of the respective methods. The advantage of the fee levelsmodels is that they have been applied across a number of fee related research questionsconsistently resulting in high explanatory power and have been robust across differentcompany and country samples as well as different time periods (Craswell and Francis,1999, p. 203). Limitations of the cross-sectional analyses relate to potential qualitydifferences between auditors and the possible impact of correlated omitted variables(Ghosh and Lustgarten, 2006). Hence, we choose a design for the levels model controllingand testing for quality differences proxied by brand name/size of the auditor (Big 4).In order to examine potential differences between companies, we next apply a firstdifference (“change”) model where the companies act as their own controls to alleviateproblems with omitted company specific variables. One advantage of using afirst-difference specification rather than a levels specification is that it directly measurestemporal fee changes rather than infers changes from cross-sectional fee differences.However, if audit fee discounts related to the abolition of the joint audit system havealready shown up in the years before the abolition due to competition, then afirst-difference specification based on data at the time of the abolition would not give

YB1 Y0 YA1 YA2 Total

Listed companies at Nasdaq OMX Copenhagen 176Excluded financial companies 55Non-financial companies 121Missing data on auditor fees 4Delisted companies 4 3 7Available fee data for univariate models 117 117 113 110 340Available (missing) company data for multivariate fee levelsmodels 108 (9) 106 (7) 99 (11) 313 (27)Available (missing) company data for multivariate feechange models 96 (21) 99 (14) 94 (16) 289 (51)

Table II.Population and

sample selection

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a complete picture of the fee changes related to the switch to single audits. We try tocounter this limitation of the change model by controlling for this effect in the levelsmodel specification by explicitly considering the level of competition prior to theabolition.

Our main audit fee levels model is specified as follows:

AuditFee ¼ aþ b1Single þ b2Dominance þ b3Big4 þ b4Size þ b5Leverageþ b6Loss þ b7OtherFee þ b8Complexity þ b9Subsidiariesþ b10Busyseason þ b11MajorShareholder þ b12IFRSþ Year Dummies þ e

ð1Þ

We apply the preferred proxy for audit fees in previous studies using logarithmictransformation of audit fees (Hay, 2012; Hay et al., 2006b). Hence, our dependentvariable AuditFee is measured as the natural logarithm of total audit fees in euros paidto the signing auditors. The difference in our study is that the total audit fee canoriginate from one (single) or two ( joint) auditors. The hypothesised fee implication isexplicitly examined using the dummy variable Single which is a dummy variable withthe value of one if the audit is conducted by a single auditor and zero if the audit isconducted as a joint audit. The single auditor variable may be endogenous if thedecision to use one or two audit firms is correlated with unobservable variables thataffect audit fees. Consistent with arguments provided by Larcker and Rusticus (2010,p. 203), we have chosen not to apply an instrumental variable method, i.e. instrumentalvariables should be theoretically justifiable as well as observable as exogenousvariables, which are correlated with the endogenous regressor but at the same timeuncorrelated with the disturbance term. As a preliminary analysis of the data, we havealso run a logit model in order to capture the decision to leave or continue with jointaudits (using the Single variable as choice variable). In addition to the variablesincluded in the fee model applied, we have examined additional variables frequentlyused in audit quality studies (Zerni et al., 2012; Francis et al., 2009). The findings(not reported in tables) are unable to identify other variables with significantexplanatory power than those included in the fee model. In recognition of theendogeneity issue, we use an alternative research design, where we introduce a proxyfor prior period competition as a main effect as well as an interaction effect, thuspicking up information that likely is related to the single auditor variable. In companieswith a very dominant joint auditor, the competitive effect on audit fees may haveshown up years ago when the “battle” for dominance took place. We include a dummyvariable (Dominance) with the value of one if the ratio between audit fees of the largestto the smallest auditor in the last year of the mandatory joint audit system (YB1) isabove the sample median, and zero otherwise. Testing the model using an alternativecontinuous proxy for dominance provides qualitatively similar results. We use theDominance variable to control for an inherited or entrenched competition or bargainingpower effect reaching into the period following the abolition of mandatory joint auditsand specifically hypothesize an interaction effect between Single and Dominance (H3).

Review papers by Hay (2012), Hay et al. (2006b) and Cobbin (2002) report that theindependent variables most commonly used in audit fee research – in other words the coremodel – are generic proxy variables for client size, complexity, risk profile, and auditorsize. We include these variables as control variables in the study. Based on Simunic (1980)and many subsequent studies (Causholli et al., 2010; Hay et al., 2006b), we expect audit

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fees to be a positive function of all the control variables except the governance variableMajorShareholder, where a prediction in both the positive and the negative direction couldbe theoretically supported as also suggested by mixed results found in different nationalsettings (Hay et al., 2006b, p. 175). Previous research shows that Big Four firms are often ina position to charge a premium price in big economies such as the USA and the UK,whereas this does not always seem to be the case in small economies such as Norway(Firth, 1997), Finland (Niemi, 2002) and Denmark (Thinggaard and Kiertzner, 2008).A premium price can reflect an oligopolistic market dominated by price cartels, a premiumfor higher litigation risk (Choi et al., 2008) and/or an extra compensation for a quality auditor for being connected with a well-known market brand in the capital market. We controlfor these factors by including a proxy for brand name/size of the auditor using a dummyvariable with the value of one if Big4 audit firms conduct all the audit (either as a singleauditor or as joint auditors), and zero otherwise. Larger companies are likely to have moretransactions and larger balances which require more audit work, hence to control for clientsize we include the natural logarithm of total assets in Euro (Size) in the model. We controlfor risk profile by including the ratio of debt-to-assets (Leverage) as a proxy for generalrisk associated with a client and a dummy variable for negative income (Loss) which canbe considered a profitability threshold at which auditors may begin to perceive increasedrisk (Burgstahler and Dichev, 1997). The provision of non-audit services by the same firmresponsible for the audit might lead to an association between the audit fee and the feecharged for other services. While the evidence from international research is mixed(Firth, 1997; Cobbin, 2002; Hay et al., 2006a) a large majority supports the hypothesis of apositive association, hence, we control for this by including the natural logarithm tonon-audit fees (OtherFee) in the model. We also test an alternative model without theOtherFee variable to assess the potential covariance problem between the Single andOtherFee variables (results based on the alternative model are qualitatively similar). Auditfees will likely increase with the complexity of the audit in itself. First we consider financialstatement items for which it is often difficult to obtain sufficient and appropriate auditevidence about whether they are free from material misstatement. Hence, the sum ofinventories, debtors and internally generated intangible assets is scaled by assets andincluded in the model as a proxy for complexity of substance (Complexity). Second weconsider the (square root of) number of subsidiaries (Subsidiaries). This is the mostfrequently used variable in fee studies as an indicator of technical complexity in an auditjob (Hay et al., 2006b). The logic is that the more subsidiaries a client has, the more complexthe audit gets and the more time-consuming the audit is likely to be.

If an audit is conducted during the busy season in the beginning of the year, fees may behigher if audit staff has to work overtime (BusySeason). In addition, we include agovernance variable (MajorShareholder) as a dummy variable with the value of one ifmajor shareholders hold more than 25 percent of direct ownership, and zero otherwise. Weuse BvD Independence Indicators B, C, D, U from the Orbis database provided by Bureauvan Dijk to capture this. The existence of a dominant shareholder could either indicatehigher agency costs or stronger control, with potentially conflicting effects on audit fees.Listed companies in EU have been required to apply IFRS in the preparation of theirconsolidated accounts commencing from the 1 January 2005. In our analysis we controlfor several audit complexity issues which may also capture audit effort in relation tospecific IFRS regulation. The Danish Financial statement Act from 2001 was actuallypre-empting many of the subsequent IFRS changes because these already were included

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in the national GAAP before 2005 (Danish Financial Statements Act, 2001). In addition, wehave compared YB1 original and YB1 restated values in the Y0 (2005) financial statementas a proxy for IFRS effect. We include a dummy variable (IFRS) with the value of one ifYB1 restatements in Y0 comparative figures resulted in absolute change in total assetsand zero otherwise.

In equation (2), we specify an audit fee change model using first-differences overtime of the variables in equation (1):

ChgAuditFee ¼ aþ b1ChgJtoSingle þ b2ChgSize þ b3ChgComplexityþ b4ChgLeverage þ b5ChgOtherFee þ b6LossNoLossþ b7NoLossLoss þ b8ChgSubsidiaries þ b9ChgIFRSþ Year Dummies þ e

ð2Þ

Chg indicates the first difference change in values between two successive years for theindividual companies. The changes represent four years of observations providingthree periods of changes, namely changes in values from YB1 to Y0, from Y0 to YA1and from YA1 to YA2. In equation (2) the hypothesised fee implication is explicitlyexamined using ChgJtoSingle which is a dummy variable with the value of one ifchange from joint audit in year before to single in current year, and zero otherwise.Similar to the audit fee change model specified by Ghosh and Lustgarten (2006) wereplace the dummy for the loss variable with two loss changes dummies, see Table I forvariable definitions. The ChgIFRS is a dummy variable with the value of one if IFRSadoption in Y0 resulted in YB1 restatements in Y0 comparative figures for total assetsand zero otherwise. Hence, the variable proxy for change in audit effort beginning inY0. The other dummy variables specified in the levels model (1) cancel out by the firstdifferencing due to the permanent nature for the individual company. Note specifically,that all companies with Big4-Big4 joint audits switching to single audits continuedwith a single Big4 auditor thereby representing an unchanged value in the Big4measure applied in the levels models. In order to facilitate interpretation and allow forunbiased estimations, we include a constant and two dummies representing timedifferences for the three periods considered (Wooldridge, 2009).

4. Correlations, descriptives and univariate analysesIn Table III, we present the pooled company year descriptive statistics for variablesincluded in the fee levels model. The 313 company-years in the pooled dataset aresubdivided into 238 with single audits and 75 with joint audits. Single audits wereimmediately preferred by 68 percent of the companies in the first year. The single auditproportion increased to 78 percent in the second year and 82 in the third year (year byyear proportions not shown in table). The result that Danish listed companies continueto voluntarily employ joint audits is consistent with results from Sweden. Zerni et al.(2012) report, that the proportion of listed non-financial Swedish companies thatemploy joint audits is roughly 10 percent. The average audit fee for Danish listednon-financial companies in 2005/2006-2007/2008 was e462.63 thousand. The split intosingle and joint audits gives a first indication of differences in audit fees between thetwo groups, with an average fee of e598.02 thousand for companies that continue withjoint audits[1] and e419.97 thousand for companies that switch to single audits.

MAJ29,2

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Wh

ole

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Dif

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gn

ifica

nt

at:

* 5an

d*

* 1p

erce

nt

lev

els

(tw

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defi

nit

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s

Table III.Descriptive statistics and

comparison betweensingle and joint audits

Joint auditsystem

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However, the difference is not statistically significant as shown in the univariateindependent sample t-test for equality of means.

These univariate results should be interpreted with caution, since the figures could beinfluenced by a few very deviating companies, and there is no control for the otherfactors introduced in the multivariate regression model. When comparing the twosubsamples we find no significant differences based on the Pearson x 2 test of equality ofmedians of the variables considered in Table III. The average size of companies whichcontinue with joint audits is e2.1 billion, while companies choosing single audits have anaverage size of e0.6 billion. There is a statistically significant difference between thejoint and single auditor groups as regards the proportion of companies which solely useBig 4 audit firms to conduct the audit. In single audits the proportion is higher(82 percent) than in joint audits (35 percent). The latter amounts to 26 joint audits withtwo Big 4 firms. The remaining 49 joint audits are divided in 46 joint audits with one Big4 and 3 joint audits without a Big 4 (this subdivision is untabled). Further examination ofthe Big 4 combinations (involving KPMG, PWC, Deloitte and EY) before and after theabolition suggests no apparent patterns of joint audit combinations. Companies withsingle audits seem to have had a more unequal distribution of the audit fees between thetwo audit firms in the last year of joint audits, i.e. higher dominance propensity.

There is also a statistically significant difference in the complexity of substanceproxy, where single audit companies seem to have a relatively higher proportion offinancial statement items for which it is difficult to obtain sufficient audit evidence.Table III shows that consultancy fees to the signing auditors are substantial inDenmark; the average of other fees for the whole population amounts to more than80 percent of audit fees. Table III also shows the sample statistics for the risk andcomplexity measures used in the regression analyses. For the whole population, theaverage for the technical complexity measure (square root of number of subsidiaries) is3.88, the average for the complexity of substance measure is 0.33, and for the riskmeasure (Leverage) 0.53. Ownership seems rather concentrated in Denmark with amajor shareholder involved in 60 percent of the company observations.

In Table IV, we provide the Pearson correlation coefficients for the variables in the feelevel models. The correlation show – as expected – a negative correlation between thesingle audit dummy and the AuditFee variable, however the correlation is not significantat the 5 percent level. The correlations between AuditFee and the other variables in theaudit fee model are significant in the predicted direction, except for the loss variable whichis significant in the opposite direction. We have no prediction for the direction (and find nosignificant correlation) between the major shareholder variable and audit fees.

Table IV shows that there is a statistically significant positive correlation betweenthe single audit dummy and complexity of substance at the 5 percent level and astatistically significant negative correlation with the number of subsidiaries at the10 percent level. All other things equal this suggests that companies prefer single auditfirms when inherent risk is large and joint audits when their business is spread over alarger number of subsidiaries. It is noticeable that the single audit dummy issignificant positively correlated with both the Big 4 and the Dominance measures.Companies which choose single audits predominately choose a Big 4 auditor and theyare characterized by having a background with an unbalanced joint audit composition(i.e. a dominant audit firm) in the year before the abolition. The latter suggests thatcompanies which chose to have a dominant audit firm in the joint audit really preferred

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Au

dit

Fee

Sin

gle

Big

4D

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ance

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age

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ther

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31

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Notes:

n¼

313;

two-

sid

edp-

val

ues

;se

ev

aria

ble

des

crip

tion

sin

Tab

leI

Table IV.Pearson correlations

for variables in feelevel models

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to give the entire audit to the dominant auditor, i.e. they switched from being de factosingle auditor companies to truly single auditor companies. The correlations also showa significant positive relationship between Size and the Big 4 dummy variable, whichsuggests that larger companies tend to choose Big 4 audit firms to carry out the wholeaudit. The correlations suggest a significantly positive association between other feesand size and between other fees and the Big 4 dummy, thus indicating that largercompanies and companies with Big 4 auditors spend relatively more money onconsultancy fees to the signing auditors.

5. ResultsLevels models – main effectsIn this section, we examine the occurrence of fee discounts based on the main audit feelevels model (1) and in the subsequent section based on the audit fee change model (2).All findings are reported after adjusting standard errors for heteroscedasticity (White,1980). Table V summarizes the results of estimating the cross-sectional regressionmodel based on audit fee levels. Our initial findings suggest that there is an audit feediscount by using a single audit firm rather than two. Table V column I shows astatistically significant coefficient of 20.18 for the Single dummy based on pooled datafrom the year of the abolition of the joint audit requirement and the followingtwo years. This suggests that for companies that switch from two to one auditor,audit fees are reduced by an average of around 16 percent[2] compared with companiesthat continue with joint audits. We have made a number of additional sensitivity testson our sample including a further examination of non-linear effects of client size andconsidered the possible implications of splitting the sample at the Size median[3].Separate regressions run on the fee level model show significant single auditordiscounts for both the small client size (n ¼ 156) and the large client size (n ¼ 157)subsamples (not shown in tables). Overall, our finding of higher fees for joint audits isconsistent with findings of higher audit fees in the mandatory joint audit system inFrance as compared to single audits in the UK and Italy (Andre et al., 2013) as well ashigher fees for voluntary joint audits in Sweden (Zerni et al., 2012).

In order to better understand the suggested fee discounts, we examine the duration indetail. Specifically, we analyse whether there are relative fee reductions from using singleauditors in the long or only in the short term (H2). In Table V column II we split the singleauditor variable in three dummy variables: first year single, second year single and thirdyear single. The first year single dummy identifies all first year single observations in thepanel data. Similarly, the second and third year single dummies collect all second and thirdyear single observations, respectively. The results show negative coefficients for all threedummy variables. However, only the coefficient for the first year single dummy isstatistically significant at the 10 percent level. This indicates that the audit fee discountsare primarily due to first year effects. This finding is also supported by additional analysesbased on individual years (not shown in tables). The relative reduction is comparable toinitial fee discounts found in other markets without the joint audit requirement(e.g. 22.4 percent in the UK market (Gregory and Collier, 1996), and 24-25 percent in theUSA (Ettredge and Greenberg, 1990; Simon and Francis, 1988)).

The variable Dominance is particular to the circumstances of our study. The maineffect of this variable is positive and significant at the 5 percent level for the modelspecifications in Table V columns I and II. This indicates that if a dominant audit firm

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III

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Notes:

Ord

inar

yle

ast

squ

ares

coef

fici

ents

,t-

stat

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csan

dtw

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p-v

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own

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stst

and

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sed

;se

ev

aria

ble

des

crip

tion

sin

Tab

leI

Table V.Relationship between

audit fees and the switchto single auditor audits

Joint auditsystem

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was involved in the audit when joint audits were mandatory, thus implying thatcompetition was low and that bargaining power was with the (dominant) auditor, thenall other things equal this will result in higher audit fees after the abolition of the jointaudit requirement. H3 hypothesizes that the single auditor effect on audit fees dependson this entrenched competition effect. We will return to this part of the argument whenwe return to a closer analysis of the potential interaction effect predicted in H3.

Table V also includes the variables from the core audit fee determinants model. Thesevariables control for other factors (besides the effect from choosing a single auditor) thatcan affect audit fees. The R 2s are very high (0.85), all VIF factors are lower than 4(Table IV), and robustness checks show that results are not unduly affected by outliers[4].All in all, this indicates that the model is well specified. We find that most control variablesfrom the core audit fee determinants model are significant at the 0.1 percent level and showthe expected signs. However, the risk proxies (Leverage and Loss) and the Big4 dummyare not statistically significant. Thus, our findings suggest that audit fees are not based onconsiderations of client risk in the financial years under study. However, this is not anunusual finding in related prior studies either, for example, Thinggaard and Kiertzner(2008) and Gonthier-Besacier and Schatt (2007). In Denmark, auditors’ litigation risk isconsidered relatively low compared with other countries (Holm and Warming Rasmussen,2008). This is in line with the observation that litigation environments in Europe generallyseem to be less aggressive than in the USA (Baker and Quick, 1996). Thus, the lowlitigation risk may explain the insignificant coefficient for the risk proxies. TheIFRS variable proxy for additional audit effort (higher fees) following the adoption of IFRSreporting standards in 2005. We find support for higher audit fees following the IFRSadoption in the pooled sample. This finding is robust for subsamples based on client size,that is, we find parallel results for the IFRS variable for both the small client and largeclient subsamples (not shown in tables).

The insignificant Big Four coefficient indicates that Big Four audit firms do notcharge premium prices when they have all the audit work (either as single auditor orwhen two Big Four audit firms conduct a joint audit). This result is in line withprevious findings in audit fee studies in smaller economies (Thinggaard and Kiertzner,2008; Niemi, 2002; Firth, 1997; Langendijk, 1997) and may reflect the fact that there isfierce competition in the audit market[5] and that Big Four auditors’ extra litigationrisk is low, or that Big Four audit firms do not perform higher quality audits for whichclients are willing to pay extra[6].

Change model resultsWe now consider H1 using a first-difference specification thus allowing the companiesto act as their own controls. The ChgJtoSingle variable in Table VI identifiescompanies that switched from a joint audit the year before to a single audit in thecurrent year. Results in Table VI column I show the effect from the very first yearwhen joint audits became voluntary. This is the year where most companies switchedto single audits. The coefficient is significant at the 10 percent level and negative,which indicates that companies experienced lower audit fees if they changed to a singleaudit firm rather than continued with two. Because a first-order difference of alogarithmic transformed measure (such as the AuditFee) is actually the percentagechange this allows for easy interpretation. This result supports the finding of a singleauditor discount as a first year effect.

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Table VI.Relationship between

change in audit feesand change to single

auditor audits

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However, the change variable is not significant when considering the pooled one yearchanges in column II. One disadvantage with the pooled dataset in column II is that thebenchmark category (no change to single) is a mixed group consisting of both companiesthat continued with joint audits and companies that did not change to single because theyalready were single. In order to get a clearer picture of the fee effects when companies dropone of their audit firms rather than continue with two, we removed companies if theyalready changed to single audits. Hence, in column III we identify the cohort of companieswith a “real choice”. The reduced number of companies with the choice of changing fromjoint to single audits is thus 147. However, the result for this reduced cohort is similar to thefull pooled dataset. Only the change from the year before to the year after the abolitionsupports an audit fee discount for companies changing from joint to single audits.

Table VI also includes changes in other variables from the core audit fee determinantsmodel. These variables control for changes in other factors (besides the effect fromswitching to a single auditor in the various categories) that can affect audit fees. All VIFfactors are lower than 2 (not shown in tables). The R 2s in the regression based on pooleddata from the three years (0.30) are modest but higher than reported in the related study byGhosh and Lustgarten (2006)[7]. While this suggests that the model is relatively wellspecified, none of the changes in control variables seem to affect the specific audit feechange in the first or subsequent years following the abolition of joint audits in Denmark.

Overall our findings are in line with the stated expectations, i.e. we find a negativeassociation between audit fees and the use of single audits, which indicates that feediscounts are attainable for companies switching to single audits (H1). Our findingssuggest that this effect is a short-term effect concentrated on the very first year whensingle audits became optional, which is also the year where most companies decided toswitch and hence experienced their first year with a single auditor (H2). Thus, theresults seem to indicate that the single audit discounts are related to competition ratherthan reflecting long-lasting efficiency gains on the part of the audit firm.

Levels model – interaction effectWe now consider whether the single auditor fee discount depends on how the joint auditwork was shared between the joint auditors before the abolition, and hence the relativebargaining power between the auditors and the client. Table V column III shows anegative and statistically significant coefficient on the interaction variableSingle*Dominance. This suggests that single auditor fee discounts are larger when adominant auditor was involved in the former joint audit. The introduction of theinteraction term means that the single auditor variable now measures the fee discountwhen two equally sharing audit firms were involved in the joint audit. The coefficient isstatistically insignificant, which indicates that there are no single auditor discounts in thiscase. The sum of the single auditor variable and the interaction term is the single auditordiscount when the former joint audit was unequally shared. The coefficient is negative andhighly significant. This suggests that the single audit fee discount is related only to singleaudits where the relative bargaining power between the client and the audit firm restedwith the audit firm and hence where competition was low (H3). We have argued that in thiscase the dominant audit firm is in a better position to determine the prices at whichsubsequent audits will be priced. Moreover, the dominant audit firm has more to lose if theclient should decide to appoint another audit firm as single auditor. These argumentscould explain why a dominant audit firm will be more willing to give a large discount

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in order to be selected as the preferred single audit firm, than when two equally sharingaudit firms are involved in the joint audit. The conditional single auditor effect may also beexplained from the alternative viewpoint of the prior audit composition. While theDominance variable in Table V column I and II suggests a positive main effect of auditfees, the introduction of the interaction term in the model clarifies that that companies witha dominant auditor will experience a continued higher audit fee if a joint audit ismaintained (the Dominance variable in column III measures the effect of prior dominancefor future joint audits), while the implication of the interaction term is that lower fees areobtained by switching to single auditors (i.e., combining the Dominance variable and theinteraction term suggest that only a minor positive effect on audit fees remains).

6. ConclusionOur study examines the consequences and implications of Denmark’s switch, in 2005,from a mandatory joint audit regime to a single auditor/voluntary joint audit regime forlisted companies. The European Commission has raised the question whether jointaudits should be considered as a means to “dynamise” the audit market in Europe. Weprovide empirical evidence to the discussions about the costs related to this. In thisstudy, we address the question of whether single audit fee discounts are related tocompetition or efficiency gains. We further address whether fee discounts depend on therelative bargaining power between the client and the auditor at the time of the decisionabout one or two auditors. Our analyses of differences in audit fee levels betweencompanies that continued with two audit firms and companies that switched to a singleauditor in the years after the abolition are initially based on the core audit feedeterminants model. We first include a dummy variable representing the use of a singleaudit firm. The association between this variable and audit fees is negative andstatistically significant, which supports H1. The results show that audit fees are reducedby an average of around 16 percent in companies that switch from two to one auditor inthe first three years after the abolition of the joint audit requirement compared withthose continuing with joint audits. However, further analyses show that the audit feediscounts in single audits are only statistically significant in the first year audit after aswitch, i.e. a short term rather than long-term effect (H2). The results from the core auditfee levels model are supported by results from an audit fee change model inspired bystudies of initial audit engagements by Ettredge and Greenberg (1990) and Ghosh andLustgarten (2006), where fee changes are measured directly and where companies act astheir own controls. The results again support H2 as a short-term effect.

In a joint audit setting the sharing of an audit between the involved auditors,competition and the relative bargaining power between the client and the auditors areinterrelated. Dye (1991) argues that the relative bargaining power between the clientand the auditor can have an effect on the incumbent auditor’s ability to raise fees abovecost for subsequent audits and hence the auditor’s incentives to offer discounts onthe initial audit. We analysed whether the single auditor fee discount depends on howthe joint audit work was shared between the joint auditors and hence the relativebargaining power between the auditors and the client in the last year with mandatoryjoint audits. Our results suggest that the single audit fee discount is related only tosingle audits where the relative bargaining power between the client and the auditfirms rested with the audit firm which supports H3. Together our results indicate thatthe discounts are mainly due to initial price cuts as a result of the special competitive

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situation created by the abolition of the joint audit requirement rather than reflectinglong-lasting efficiency gains on the part of the audit firm.

Our particular research design involves strengths as well as limitations. The change inregulation provides a natural experimental setting and the benefit of a full populationexamination is that the full variation of possible outcomes is covered. The limitation is thatthe number of observations is constrained by the particular setting. This is a limitation interms of the possible inferences made on audit fee developments, but also in terms of dataavailability for analysis of potential differences in audit quality. The validity of thereported findings is of course subject to the use of an appropriate research design. Weacknowledge that unobservable variables may affect audit fees in a manner not consideredin the chosen design. These caveats are shared by a number of prior fee studies based onarchival data. Future research would benefit from new theoretical models considering thecomplexity of joint audit client/auditor relationships, including such conditional factorsidentified in our study. Further research on the role of bargaining power in joint auditsituations could examine the potential interactions between same type auditor firms(Big Fours) and different type audit firms (Big Four vs non Big Four). In addition, the areacalls for more research taking a more qualitative research approach to examine whetherthe use of a single audit firm rather than two has an effect on audit quality.

Notes

1. Gonthier-Besacier and Schatt (2007) report an average of e445 thousand in 2002 for127 French joint audit companies that voluntarily disclosed their audit fees.

2. The implied fee reduction (r) can be found by: r ¼ e2 c 2 1, where c – reported coefficient;see Gregory and Collier (1996), footnote 2.

3. We have also tested for non-linear effects using Ramsey’s Reset test and specificallyexamined the potential for using powers of the Size variable in order to assess the robustnessof the reported results. In addition we have generated dummy variables for each decile of theraw size measure and re-run our regressions with these variables. The main findings arerobust to the inclusion of these alternative size measures. We thank an anonymous reviewerfor suggesting these additional tests.

4. We have performed sensitivity tests by winsorising the continuous variables to the1st/99th and 5th/95th percentiles and our findings are qualitatively similar to the reportedfindings on all the hypothesized relationships, as well as, the direction and significance of allthe control variables in models presented. Trimming (excluding) the data from the smallestand largest companies have no differential effect on the findings either. Because we want toshow the full variation of the data for the whole population of non-listed companies, we havechosen not to winsorise or trim in the findings reported.

5. Fierce competition is supported by a report by London Economics and Ewert (2006) for theEuropean Commission which shows that Denmark is one of the countries in the EU with theleast concentrated audit markets.

6. We carried out an additional test, which included an interaction variable between theSingleAuditor variable and the Big4 variable, in order to analyse whether there is a marginaleffect from being audited by a single Big 4 audit firm. Results (not reported) showed that thecoefficient was insignificant, i.e. the audit fee discount when changing from a joint to a singleaudit does not seem to be depend on the size of the single auditor.

7. Note that the standard deviations are based on robust standard errors, and that the R 2s arenot adjusted in this model.

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Corresponding authorClaus Holm can be contacted at: hoc@asb.dk

To purchase reprints of this article please e-mail: reprints@emeraldinsight.comOr visit our web site for further details: www.emeraldinsight.com/reprints

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This article has been cited by:

1. Claus Holm, Frank Thinggaard. 2015. Paying for Joint or Single Audits? The Importance of AuditorPairings and Differences in Technology Efficiency. International Journal of Auditing n/a-n/a. [CrossRef]

2. David Hay. 2015. The frontiers of auditing research. Meditari Accountancy Research 23:2, 158-174.[Abstract] [Full Text] [PDF]

3. Kim Ittonen, Per Christen Trønnes. 2015. Benefits and Costs of Appointing Joint Audit EngagementPartners. AUDITING: A Journal of Practice & Theory 34, 23-46. [CrossRef]

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