Auditing principles and practices

¶ … Big 4, 'Next 4', and Smaller Accounting Firms: Resignations v. Dismissals and the Outcome of the Auditor Change Process" by Dr. Charles P. Cullinan and Dr. Hui Du addresses the issue of auditing services among publicly traded companies. As such, the article begins by noting that there has been a general loss of market share by Big 4 firms, amounting to a decrease of about half, from 44% to 22%. The article examines whether this is the result of accounting firms resigning from clients, or client decisions to change auditors.

Purpose/Goal/Thesis

The purpose of investigating these realignments of auditor-client relationships culminates in the more specific objective of the paper, to examine auditor-client realignments between 2003 and 2008 to determine its nature as driven by auditors or clients. Furthermore, the research is unique in terms of its focus not only upon the Big 4 vs. non-Big 4 paradigm, but also upon a new tier of firms known as the "Next 4." Firms that are neither Big 4 nor Next 4 are referred to as "Smaller Firms."

3) Literature Review

In addition to an extensive literature review, this section of the paper also includes research questions to be examined. The literature review includes various sections, as relevant to the purpose and goal of the article. The authors note for example that the auditor change literature generally recognizes only Big 4 and non-Big 4 auditing firms, while other areas of auditing literature is somewhat more flexible, by examining a three tier market for audit services. Such literature recognizes the differences among auditing firms to warrant the classification of an auditing tier between the Big 4 and Smaller Firms.

In addition to an examination of auditor resignation vs. dismissal, the literature examined also indicate differences in the nature of auditor resignation, where an increased litigation risk makes it more likely for auditors to resign from their clients.

Another important issue is the fact that auditors tend to be dismissed when their fees are perceived as excessively high for the services provided. This generally occurs in the case of Big 4 firms, where clients tend to replace such auditors with lower-tier professionals who charge less for the same service.

4) Methodology

The researchers began their work by obtaining a list of auditor changes for the years to be examined from AuditAnalytics. There is a clear distinction from auditor changes as a result of resignation and as a result of dismissal.

The main variable for the study is the tier of the accounting firm in question, with Big 4, Next 4 and Smaller Firms coded as 3, 2, and 1 respectively.

Analyses were performed to determine the prevalence of resignations among the different types of accounting firms; the relationship between tier status and audit fee; and the likelihood of engaging lower-tier audit firms when audit firms have resigned.

5) Implications, Findings, and Conclusions

The researchers found that there was a significantly higher likelihood of Next 4 accounting firms to resign than Big 4 or Smaller Firms. Big 4 firms are also found to charge higher fees than other firms, while Next 4 and Smaller Firms do not show a significant differentiation in the fees that they charge.

It is also found that, upon resignation of a firm, the client is more likely to engage a successor from a lower tier than when accounting firms are dismissed. In general, it is found that auditor realignment decisions are mainly client-based.

The implication of these findings is that more meaningful insights into the auditing market might be obtained by classifying audit firms into a three-tier market rather than the Big4/Non Big-4 dichotomy.

There are two main conclusions from the study. The first is that the lower incidence of resignations by Big 4 firms than Next 4 firms is somewhat surprising. It is suggested that the materially higher fees charged by these firms is an induction for "less desirable" clients to dismiss their auditors. This is an important springboard for further study.

Further, a possible explanation for the higher prevalence of resignations by Next 4 firms as compared with Smaller firms is that they may face a higher demand than capacity, as they represent a higher tier status than Smaller Firms, but do not charge significantly higher fees. This higher demand then also encourages a higher level if resignation by these firms.