LIM, Hyoung-joo and MALI, Dafydd (2015). Do audit fees and audit hours influence credit ratings?: A comparative analysis of Big4 vs Non-Big4. Korea International Accounting Review, 2015 (63), 1-24. [Article]
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Abstract
We examine the relationship between credit ratings / changes and audit fees (hours) for Big4 and
Non-Big4 firms. Audit fee (hours) may be considered as a default risk metric for credit ratings agencies.
However, firms audited by Big4 are larger, better performing and operate with lower leverage compared
to firms followed by Non-Big4. Therefore, the association between audit fee (hours) may be different for
firms followed by Big4 and Non-Big4 audit firms. We find that there is a negative association between
audit fees and credit ratings for firms followed by Big4 audit firms. However, we find an insignificant
relation for firms followed by Non-Big4. We conjecture the different association due to the Big4 firms
having more robust accounting procedures; Big4 firms must offer competitive audit fees because they
are engaged in fierce competition with other Big4 firms. Moreover, Big4 and Non-Big4 firms have
different relationships with their clients because Non-Big4 firms are more income dependent on their
clients.
Using a sample of 1,717 firm–year observations between 2002 and 2013, we establish a relation
between audit fees in period t and credit ratings in period t+1, for firms followed by Big4 auditors. We
do not find a significant relation for firms followed by Non-Nig4 firms, suggesting that credit ratings
agencies perceive audit fee differently for Big4 and Non-Big4 firms. Client firms followed by Big4 auditors
that experience a credit rating change in period t+1 pay lower audit fees in period t compared to firms
that do not experience a credit rating change. Our additional analysis suggests a different association
between firms audit fees and firm performance for firms that experience a credit rating increase and
decrease. Firms that experience a credit ratings increase in period t+1 have strong performance and
lower audit fees in period t. On the other hand, firms that experience a credit rating decrease have
weak financial performance and negative audit fees compared to firms that do not experience a credit
ratings change. Our results suggest that audit fees combined with financial performance influence a
credit ratings agency' perception of default risk.
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