Are the Big 4 Audit Firms Homogeneous? Further Evidence from Audit Pricing

We provide new evidence on audit pricing differences within the Big 4 audit firms in the U.S. market. Industry expertise research argues that an audit firm with greater competencies can differentiate itself from competitors in terms of within&#8208;industry market share and charge an audit fee premium for its services. We show that while KPMG's average fee premium is smaller than those of other Big 4 audit firms, PricewaterhouseCoopers consistently earns an above&#8208;average fee premium and has remained the market share leader across most U.S. industries. More importantly, the supposed effects of industry specialization on audit fees become statistically insignificant after controlling for individual pricing differences within the Big 4. Overall, we conclude that the Big 4 firms are not homogeneous in audit pricing, and that the literature has apparently confounded an individual audit firm reputational effect (as first observed by Simunic, 1980) with an industry specialist fee premium in the U.S. audit market.


| INTRODUCTION
The dominant Big 4 public accounting firms (KPMG, Deloitte, EY, and PwC), which have long been argued to offer differentially higher audit quality than non- Big 4 firms (DeAngelo, 1981), are treated as a homogeneous set in extant research. However, in Simunic's (1980) classic study, a statistically significant audit fee premium, ceteris paribus, was observed for clients of Price Waterhouse (later PwC) 1 relative to other firms in the (then) Big 8. This finding was interpreted as consistent with price competition in the audit market, with a (somehow) differentiated product offered by Price Waterhouse (PW) and purchased voluntarily by PW clients. In addition, Peat Marwick (later KPMG) 2 has been labeled a price cutter and found to earn below-average audit fee premiums (Bernstein, 1978;Moizer, 1997), again relative to the other Big firms. However, empirical results in the 1990s and 2000s did not show a significant premium or discount for any Big audit firm. Instead, research shifted to the possible existence of auditor-industry specialization (Craswell, Francis, & Taylor, 1995), and tested the hypothesis that developing industry-specialized expertise facilitates delivering high-quality audits, thereby increasing auditor reputation and earning such industry specialist auditors a significant fee premium.
In this study, we focus on audit pricing differences during the period 2003-2017 within the Big 4 firms, which are the dominant suppliers of audit services to U.S. public (listed) companies. Answering Hay's (2013) call for more studies on the PwC premium, we raise the empirical question of whether, besides the general Big 4 audit fee premium, individual pricing differences can be detected within the Big 4 firms in the U.S. market. If the Big 4 are truly a homogeneous set of high-quality firms and earn significant fee premiums due to their brand name reputation as a group, there should be no significant systematic audit pricing differences among them. However, we find that PwC has not only maintained its position as the market share leader in the United States but also earns an above-average audit fee premium over the other Big 4 firms. 3 We also find that KPMG has been identified as an industry specialist in the fewest industries and earns a below-average fee premium relative to the rest of the Big 4. Moon, Shipman, Swanquist, and Whited (2019)  show that these premiums persist when clients are classified into size quintiles. This suggests that the premiums are associated with auditor brand names rather than with client characteristics that drive audit fees, most important of which is client size. We then extend our analyses by considering the interaction between individual audit firm pricing differences and auditor industry specialization, and show that individual audit firm brand names are important determinants of the fee premiums earned by industry specialists.
According to the GAO (2008), large companies primarily choose Big 4 audit firms as their external auditors due to their general technical capabilities and industry-specialized expertise. Thus, each audit firm has to compete intensively to meet the demand for high audit quality through developing brand name reputation and industry specialization . A useful illustration is provided by PwC (2012, p. 3): The PwC Network has invested hundreds of millions of dollars in the development and roll-out of a new proprietary global audit software tool that will help further improve quality on even our most complex multinational clients; trains over 60,000 audit professionals annually at a significant cost; and maintains global systems to provide controls over audit quality and compliance with many independence requirements-both those imposed externally and those required by PwC internal policy.Therefore, both generalized expertise and industry-specialized expertise are likely to enable differentiation of the audit services within the Big 4 firms, improve audit quality, and result in higher audit fees.
Although the concept of auditor industry specialization has been extensively examined in the auditing literature, there is no consensus on how to empirically measure specialization. Because the actual level of specialization of audit firms is unobservable, several proxy measures have been introduced that reflect the complexity of the concept, including market share-based measures Zeff & Fossum, 1967), the portfolio proportion of clients (Kwon, 1996), and weighted market shares (Neal & Riley, 2004). Audousset-Coulier, Jeny, and Jiang (2015) recently showed that these approaches yield inconsistent classifications of audit firms as industry specialists, and subsequently lead to inconsistent inferences from audit pricing and earnings quality models.
Using the within-industry market share approach to measure industry specialization, we find that PwC is designated an industry specialist in the highest number of industries (Audousset-Coulier et al., 2015;Cahan, Jeter, & Naiker, 2011;Knechel, Naiker, & Pacheco, 2007;Li, Xie, & Zhou, 2010), followed by Ernst & Young (EY), Deloitte, and KPMG. This raises a further empirical question of whether an individual audit firm's generalized competencies confound the effect of industry specialization on audit pricing. Accordingly, to test whether the lack of proper control over the historically observed PwC fee premium significantly affects the inferences drawn from the audit pricing model, we examine the differential effect of industry specialization on the audit fees charged by each Big 4 firm. In particular, we find that the observed fee premium for specialists is highly sensitive to the identity of the incumbent auditor. After controlling for individual differences within the Big 4 firms, we find that the industry specialization fee premium is only detected and significant for EY and Deloitte specialists, and not for PwC and KPMG specialists.
In additional analyses, we estimate the audit fee model partitioned by asset size quintiles to prevent the model's residuals from being correlated with client size. We find that the evidence of audit pricing differences at the interaudit firm level is robust to client size subsample regressions. Sensitivity tests using audit firms' competitive position (Chu, Simunic, Ye, & Zhang, 2018;Numan & Willekens, 2012), a measure of unexplained audit fees (hereafter UAF), and two alternative measures of industry specialization at the metropolitan statistical area (hereafter MSA) level (Ferguson, Francis, & Stokes, 2003;Francis, Reichelt, & Wang, 2005) further confirm that individual differences within the Big 4 firms strongly impact on the industry specialization effect in the audit feel model.
Our study makes several contributions to the auditing literature. First, while Big 4 firms are typically treated as homogeneous and identified using a Big 4 dummy variable, we document that PwC (KPMG) earns an above-average (below-average) fee premium, indicating that there are systematic pricing differences at the interfirm level. The evidence of variation in audit pricing at the interaudit firm level suggests that Big 4 firms are not homogeneous and that individual brand names, which capture generalized firm expertise and reputation, play an important role in the audit market, partially explaining existing differences among these firms. Second, and more importantly, we explain the inconsistent results regarding the impact of industry specialization on audit fees by showing the differential effect of industry specialization on the audit fees charged by each Big 4 firm, which are necessary to support the existence and maintenance of a differentiated brand.
Overall, we document the importance of distinguishing among individual Big 4 firms and argue that treating all Big 4 firms as homogeneous creates a potentially significant omitted variable in certain audit fee studies (Hribar, Kravet, & Wilson, 2014). Beyond this technical result, our findings reinforce the importance of capital investments for understanding audit production and the market for audit services.
Most auditing research treats audit production as a black box in which labor hours are somehow transformed into audit assurance (O'Keefe, Simunic, & Stein, 1994). This characterization makes it difficult to explain the differences between Big 4 and non-Big 4 firms, and also provides no basis for differentiation within the Big 4. However, when both capital investments and labor hours are incorporated into audit production (Sirois, Marmousez, & Simunic, 2016), it is natural for product differentiation to arise in a market. This can occur at the group level (i.e., , client-industry level (i.e., specialist vs. nonspecialist), and individual supplier level. Our article can, therefore, be viewed as an indirect test (through audit pricing) of the relative importance of capital investments at these various levels. Capital investments and their role in oligopolistic competition have been examined in the economics literature (Sutton, 1991). However, the potential importance of audit firm specific investments has essentially gone unrecognized in the auditing literature.

| LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT
While the auditing literature typically uses Big 4/5 membership 4 as a surrogate for audit quality (DeAngelo, 1981), DeFond and Zhang (2014) argue that larger audit firms have not only greater incentives (e.g., reputation loss from ex post discovery of low audit quality) to supply high-quality audits but also greater competencies (e.g., better audit inputs, industry expertise) to deliver high-quality audits. Thus, researchers have begun to tease out the effects of competencies on audit quality using several auditor characteristics, including auditor industry specialization and general audit firm competencies.

| Evidence from auditor industry specialization
The concept of auditor industry specialization was introduced in the early literature to examine quality variation at the inter-audit firm level. The supply of quality-differentiated audits can be motivated by agency and contracting theory (Jensen & Meckling, 1976;Watts & Zimmerman, 1983) as service differentials explain both brand name and industry specialization reputation as a function of increasing agency costs. Craswell et al. (1995) argue that there is a demand for quality-differentiated audits based on industry expertise, which drives audit firm investments in technology and expertise to develop industry specialization. Because developing such expertise is costly, industry specialization is presumably associated with higher audit fees (Carson, 2009;Ferguson et al., 2003;Francis et al., 2005) and higher quality audit services (Balsam, Krishnan, & Yang, 2003;Lim & Tan, 2010;Romanus, Maher, & Fleming, 2008).
In early studies, Zeff and Fossum (1967) and Palmrose (1986) identified industry expertise based on the market share of each audit firm in each industrial category. The market leader is designated an industry specialist on the assumption that industry specialists provide higher audit quality, attract more clients, and ultimately build larger market shares. Because information on audit fees was not publicly available before the 2000s, the choice of variables for calculating auditor market share has not been consistent in the literature. For example, some researchers use client size or the number of audit clients as alternative proxies to calculate the market share of each audit firm.
An alternative way to identify industry specialists is the client portfolio-based approach (Kwon, 1996;Neal & Riley, 2004), which assumes that industries in which a given audit firm holds the largest portfolio share reflect that firm's allocation of higher-than-average resources and its development of industry-specific knowledge. This approach captures the aggregate distribution of audit services across various industries for each audit firm, and defines industries in which an audit firm is considered an industry specialist as those that constitute its three largest portfolio shares. Neal and Riley (2004) also introduced the weighted market share cut-off, which captures the complementary effects of the market share and portfolio approaches.
While the impact of industry expertise on audit pricing and audit quality has been extensively examined in the literature, the results of studies on industry specialization suggest that PwC has managed to differentiate itself from competitors regarding its within-industry market share position. For example, Knechel et al. (2007)

| Evidence from audit firm competencies
The classic study by Simunic (1980) provides early evidence of a significantly positive coefficient on a PW dummy variable in the audit pricing model, suggesting that the measure captured some unique characteristics of that firm and/or its clients that resulted in a significant fee premium relative to other Big 8 firms. Moizer (1997) showed that in addition to the top-tier audit fee premium, PW and Peat Marwick earned audit fee premiums and discounts, respectively, in the U.S. market. Another quality-differentiated characteristic of large audit firms documented by Dunn and Mayhew (2004) is that Coopers and Lybrand LLP (later PwC) provided additional services beyond the standard audit through implementing enhanced financial disclosure practices.
While studies in the 1990s and early 2000s did not show a significant premium for any audit firm in the United States, Hay, Knechel, and Wong (2006) and Hay (2013) argue that there is some evidence of PwC receiving a significant fee premium in international settings (Firth & Lau, 2004;Pong & Burnett, 2006). Ferguson and Scott (2014) also document that the Australian market over the period 2002-2004 was dominated by the three largest audit firms-PwC, EY, and KPMG-and that the overall audit fee premium for this group of firms was driven by a robust PwC fee premium.

| Hypotheses development
The nature of competition among the Big 4 audit firms has been a concern for regulators, particularly when the audit market is highly concentrated and dominated by the four largest firms. However, the survey results of the GAO (2008) conclude that the current level of concentration does not adversely affect auditor choice, audit prices, and audit quality. Also, PwC (2012) argues that there is intense competition among the large audit firms to develop their own networks and intensively invest in industry expertise, audit methodologies, and talented people, so as to meet the market's demands for high-quality audits and effectively serve the capital markets at competitive prices. This is consistent with the analysis of Sirois et al. (2016), who argue that the Big 4 firms behave as noncolluding oligopolists who make capital investments in technology and other inputs (e.g., staff training) to distinguish themselves from their peers, thereby providing high levels of audit value (quality/price), and consequently dominating the market for audit services. This characterization is also consistent with statements on the Big 4 firms' official websites: At PwC, we're doing just that-investing in leading-edge technology, significant process improvements, and leadership and performance development for our people.
With a common, consistent strategy and structure, we [EY] serve our global and local clients with the same intensive focus on quality.
Applying Lean methodologies to the financial statement audit in order to help enhance audit quality and increase value is a uniquely 2002. The requirements of SOX substantially increased audit effort and expected legal liability, which subsequently led to higher audit fees (Ghosh & Pawlewicz, 2009;Griffin & Lont, 2007). We hypothesize that the individual firm reputational effect, particularly the PwC effect, is associated with above-average fee levels, consistent with Simunic's (1980) early evidence of a PW effect. Our first hypothesis is as follows: H1. PwC earns a significant audit fee premium compared to other Big 4 firms.
Next, we break down industry specialists by audit firm and fiscal year. While each of the Big 4 firms is well represented in the distribution of industry specialists, we note that PwC is designated an industry specialist most often across industries and years, followed by EY, Deloitte, and KPMG (Cahan et al., 2011;Knechel et al., 2007;Li et al., 2010). Given the prevalence of PwC and EY across most auditor industry specialization measures, the question arises of whether a lack of proper control for individual differences in fee premiums within the Big 4 significantly affects the observed association between audit fees and industry specialization. We hypothesize that the individual firm reputational effect is more relevant to determining price premium than the industry specialization effect. The second set of hypotheses are as follows: H2. The industry specialization fee premium is confounded by the individual firm reputational effect.
H2a. : PwC specialists earn a significant audit fee premium compared to PwC nonspecialists.
H2b. : EY specialists earn a significant audit fee premium compared to EY nonspecialists.
H2c. : Deloitte specialists earn a significant audit fee premium compared to Deloitte nonspecialists.
H2d. KPMG specialists earn a significant audit fee premium compared to KPMG nonspecialists.

| RESEARCH DESIGN
To test H1, we investigate whether there are cross-sectional differences in audit pricing within the Big 4 firms by breaking down the Big 4 indicator variable into four individual firm indicator variables (PwC, EY, KPMG, and Deloitte). Based on existing audit fee studies (Hay, 2013;Hay et al., 2006;Simunic, 1980), we estimate the following empirical model, whose variables are defined in Table 1: + α 4 LEVERAGE t + α 5 ROA t + α 6 MTB t + α 7 ATENURE t + α 8 LNBUSSEG t + α 9 LNGEOSEG t + α 10 SPI DM t + α 11 LOSS t + α 12 MA t + α 13 IPO t + α 14 SEO t + α 15 BUSY t + α 16 HIGHLIT t + α 17 OPINION t + α 18 ICWEAK t + α 19 AUDCHG t + α 20 PwC t + α 21 EY t + α 22 KPMG t + α 23 Deloitte t + Year and Industry Fixed Effects + ε t H1 predicts that the estimated coefficient of PwC will differ from those of the other Big 4 firms. Specifically, we expect α 20 (PwC) to be significantly larger than α 21 (EY), α 22 (KPMG), and α 23 (Deloitte). Additionally, to focus on the pricing differences between these major audit firms, we exclude client firms audited by non-Big 4 audit firms and rerun the audit fee model including Note. This table reports the summary statistics of variables used in the audit fee model from fiscal year 2003 to 2017. All continuous variables are winsorized at the 1 st and 99 th percentiles. Variable definitions for the audit fee model are as follows: LNAFEES = the natural logarithm of audit fees; LNTTFEES = the natural logarithm of total fees (the sum of audit fees and non-audit fees); LNASSET = the natural logarithm of total assets (in millions); CURRENT = the ratio of current assets to current liabilities; INVREC = the ratio of total inventory and receivables to total assets; LEVERAGE = the sum of short-term and long-term debt, divided by total assets; ROA = income before extraordinary items, scaled by total assets; MTB = the firm's market value divided by its book value; ATENURE = the number of years the company has been audited by the same audit firm; LNBUSSEG = the natural logarithm of one plus the number of business segments; LNGEOSEG = the natural logarithm of one plus the number of geographical segments; SPI_DM = indicator variable equal to one if an audit client has a special item during the year, and zero otherwise; LOSS = indicator variable equal to one if income before extraordinary items is negative in the current period, and zero otherwise; MA = indicator variable equal to one if an audit client is engaged in a merger or acquisition during the year, and zero otherwise; IPO = indicator variable equal to one if an audit client is engaged in an initial public offering during the year, and zero otherwise; SEO = indicator variable equal to one if an audit client is engaged in a seasoned equity offering during the year, and zero otherwise; BUSY = indicator variable equal to one if an audit client's year-end falls on December 31, and zero otherwise; HIGHLIT = indicator variable equal to one for high litigation risk industries as defined by Francis, Philbrick, and Schipper (1994), and zero otherwise; OPINION = indicator variable equal to one if an audit client receives a modified audit opinion, and zero otherwise, where a modified opinion is defined as anything except a standard unqualified audit opinion coded as one by COMPUSTAT; ICWEAK = indicator variable equal to one if the auditor's opinion of the effectiveness of the company's internal control is adverse or disclaimer, and zero otherwise; AUDCHG = indicator variable equal to one if there is a change in auditor in the current period, and zero otherwise; BIG4 = indicator variable equal to one if the firm's auditor is a member of the Big 4 audit firms (PwC, EY, KPMG, and Deloitte), and zero otherwise; PWC (EY, Deloitte, KPMG) = indicator variable equal to one if the firm's auditor is PwC (EY, Deloitte, and KPMG, respectively), and zero otherwise.
variables identifying audits by PwC, EY, and Deloitte (with KPMG audits in the intercept). We also examine trends in auditor premiums over time by dividing our sample into three equal time periods (2003-2007, 2008-2012, and 2013-2017) and investigating whether the variation in auditor premiums remains constant over time. together with the firm with the second largest market share in industries with less than 10% difference in market share between the top two firms. To be designated an industry specialist under the market share cut-off approach, an audit firm must earn audit fee revenue from an industry that amounts to at least 30% of the total audit fees paid to all firms in that industry. Finally, because the choice of variables used to calculate market share is not consistent in the literature, we also include AT_30 and NC_30 as alternative proxies of industry specialization using client asset size and the number of audit clients, respectively (rather than audit fees), to measure the market share in each industry. We

| Sample selection
Our sample includes all U.S. listed firms with available datasets from the Audit Analytics database from 2003 through 2017. We then  Table 3, Panel A. FE are industry and year fixed effects. *, **, *** denote significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed tests. T-statistics are based on clustered standard errors at client firm level. merge these data with the Compustat fundamental annual files to obtain necessary financial data for all firm-year observations. We exclude all observations related to firms in the financial (SIC 6000-6,999) and utility (SIC 4900-4,949) industries because the audit fee model for these firms differs from that for other industries (Fields, Fraser, & Wilkins, 2004;Hay et al., 2006). We also exclude firms with missing values and firms with total assets of less than $1  To provide detailed insight into the rankings of each major audit firm across the sample period, Table 2   Given that client size is the factor most closely related to auditor selection (e.g., Lawrence, Minutti-Meza, & Zhang, 2011), we divide each year and industry sample into quintiles based on total client assets and report the results using the same format as in Table 3. We report the results in Table 4, which documents that the PwC coefficients are significantly larger than those of KPMG across all asset size quintiles, particularly in smaller quintiles. We also provide evidence of a significant pricing difference between KPMG and both EY and Deloitte, particularly when the sum of audit fees and nonaudit fees in the audit fee model.  Note. Variable definitions for auditor industry specialization measures: AF_DOM (AT_DOM, NC_DOM) = indicator variable equal to one if the audit client uses an audit firm whose market share based on aggregated audit fees (aggregated client assets for AT_DOM, number of clients for NC_DOM) is either the largest or the second largest in industries with less than 10% difference in market share between the top two firms, and zero otherwise; AF_30 = indicator variable equal to one if the audit client uses an audit firm whose market share based on aggregated audit fees is greater than or equal to 30% in that particular industry, and zero otherwise.

| EMPIRICAL RESULTS
four individual firm indicator variables in Panel C. While the estimated coefficients on individual Big 4 firms remain positive and significant at less than the 1% level, the industry specialization premium is only observed for EY and Deloitte specialists (Columns 1 and 2) when the audit fee-based measures are used to identify industry specialists, and not for PwC and KPMG specialists. 13 To control for the possibility that the interactive effects of the control variables are correlated with the interactions of SPEC and each audit firm indicator, we extend the regression model in Table 6 and include interactions of SPEC and each control variable. We find that the main inferences are unchanged when we use a fully interacted model. Note. This table presents regression results of the audit fee model for LNAFEES including auditor industry specialization measures (SPEC) and their interaction term with each individual audit firm indicator variable. Control variables are the set given in Table 3, Panel A. FE are industry and year fixed effects. *, **, *** denote significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed tests. T-statistics are based on clustered standard errors at client firm level.
Taken together, our results suggest that the variation in audit pricing at the interaudit firm level has a strong impact on the measured audit fee effect usually attributed to industry specialization.
We perform several sensitivity tests to determine the sensitivity of our main results to different specifications. which negatively affects the pricing power of (smaller) incumbent audit firms. A low value of DIFF_AFEE implies that an audit firm has a strong competitive position relative to the dominant market firm, while a high value of DIFF_AFEE implies that an audit firm is a small player in a market and has a weak competitive position.

|
In Table 7, while we consistently observe a negative and highly significant coefficient on the difference in market shares (DIFF_AFEE), we do not observe statistical significance in either of the Big 4 specialists' groups (Columns 1 and 3). Columns (2) and (4) report results when we include each individual audit firm indicator variable, the industry specialization measure, and its interaction term in the audit fee model. Overall, we find that the effects of auditor industry specialization largely become either negative or insignificant when we include competitive position in the analysis. Also, we consistently find that KPMG specialists earn a below-average fee premium compared to those of other Big 4 specialists after controlling for the audit firm's competitive position in the market.
T A B L E 7 Audit fee model: Estimation of industry specialist premium with audit firm's competitive position Note. This table presents the regression results of the audit fee model including auditor industry specialization measures (SPEC) and audit firm's competitive position (DIFF_AFEE). Control variables are the set given in Table 3  firm-year observation. We then classify an audit firm as an industry specialist using two audit fee-based measures at the MSA level: CAF_LRG, which represents an audit firm with the largest market share in each two-digit SIC code and fiscal year; and CAF_30, which represents an audit firm with a market share greater than or equal to 30%. The results are reported in Table 9.
Again, while the fee premium earned by Big 4 specialists
[1] SPEC Note. This table presents the regression results of the audit fee model including alternative measures of industry specialization at the MSA level.
*, **, *** denote significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed tests. T-statistics are determined by clustered standard errors at client firm level. Variable definitions: CAF_LRG = indicator variable equal to one if the company uses an audit firm with the largest market share in that particular industry at the MSA level, and zero otherwise; CAF_30 = indicator variable equal to one if the company uses an audit firm whose market share based on aggregated audit fees is greater than or equal to 30% in that particular industry at the MSA level, and zero otherwise; DIFF_AFEE_MSA = the difference in market share based on aggregated audit fees between the incumbent audit firm and the largest firm in each two-digit SIC industry at the MSA level.
together, our findings suggest that the effects of industry specialization on audit fees are highly sensitive to individual differences within the Big 4 firms.

| CONCLUSION
In this article, we tested the importance of specific audit firm reputations by investigating audit pricing differences for listed clients across Big 4 audit firms during the period 2003-2017. In addition to the general Big 4 fee premium, we argue that individual audit firm reputation also plays an important role in the U.S. market, enabling PwC (KPMG) to earn an above-average (below-average) fee premium relative to the other Big 4 firms.
Furthermore, we argue that the positive relationship between audit fees and auditor industry specialization documented in the literature is exaggerated by the confounding effect of the individual audit firm's generalized competencies. After controlling for individual price differences within the Big 4 audit firms, we find that the industry specialization premium is only observed for EY and Deloitte specialists, and not for PwC and KPMG specialists.
Overall, this study demonstrates that it is not appropriate to treat the Big 4 audit firms as a homogenous group, since we evidence that these firms are not the same in their pricing of audit services, ceteris paribus. Our findings are consistent with Sirois et al.'s (2016) argument that Big 4 firms act strategically to distinguish themselves from competitors by making capital investments in technology and other inputs. These investments allow the Big 4 firms as a group to dominate the audit services market by providing superior average audit value (audit quality/audit price) relative to non-Big 4 firms. They also provide a basis for individual firms to differentiate themselves from one another. PwC's above-average audit fee premium indicates that, over time, the firm has quite successfully distinguished itself from the other Big 4(6)(8) firms. Conversely, KPMG's below-average audit fee premium implies that the firm has not made the same level of investments as the other Big 4 firms. We conclude that individual differences within the Big 4 firms are key to understanding the economic forces operating in the audit services market.
possible that company characteristic(s)-as opposed to auditor characteristic(s)-explain a portion of the variation in audit fees across auditors (e.g., tolerance for risky clients could vary significantly across audit firms). To control for this selection effect, we follow Ireland and Lennox (2002) by employing a two-stage Heckman (1979) selection model. Specifically, we estimate the audit fee model and include the inverse Mills ratio calculated based on the annual regression results from the following auditor selection model: BIG4 t = α 0 + α 1 LNASSET t + α 2 ATURN t + α 3 CURRENT t + α 4 LEVERAGE t + α 5 ROA t + ε t Consistent with the main analyses, we find that, on average, PwC earns a significant audit fee premium relative to the other Big 4 firms after controlling for the Mills variable. 12 In untabulated results, we find that the Spearman correlation coefficients between the indicator variable for PwC and various industry specialization measures range from 0.35 to 0.45 and are significant at less than the 1% level.