The Mechanism And Objectivity Of Audit Quality Premiums

In the mature market, the price recognition process of all kinds of physical merchandise should obey the rule "price against essence", as a dummy product of service, whether audit service should samely conform to the rules such as "price stands for quality"? Many audit researchers have been conducting tough studies for a long time to get the answer to this question which looks very simple(Simunic,1980;Firth, 1985; Chan et al.,1993; Pong & Whittington, 1994; Simon, 1995 etc.). After series of syllogism and empirical analysis, nearly all scholars get the positive answer to this question, viz. the better auditor requires the higher audit fees. In this article, the excess audit reward that possible gained on basic of high-quality service is defined as "audit quality premiums" by me, and extend to a series of study and research with this theme.After reviewing the previous relative documents, I found that the number of such thesises covering the theme of "audit quality premiums" is great, and find a lot of defects in the researches on this topic at the same time: Firstly, scholars generally come to the conclusion that famous firms' audit (e.g. "Big Four") being equal to high-quality audit after some simple theoretic analysis and deduction, and consider the brand (size) of audit firms as the substitute variable of audit quality in the audit price models built by them, while such simple approach is worth of discussion furtherly. As the basic assumption of the empirical research of "audit quality premiums", the substitute variable of audit quality should be confirmed after a series of scientific and reasonable argumentation and empirical verification, only these conducts, the reliability of the econometric models about "audit quality premiums" can be enhanced effectively. Otherwise, the reliability of the econometric models setup on the conclusion that brand (size) of audit firms stands for the hypothesis of audit quality may be doubtable; secondly, the reason that high-quality audit firms (e.g. "Big Four") own premiums is often deduced and analyzed from the current theories like "Deep Pocket", "Risk Compensation", etc. by most scholars, they scarcely conclude and verify the inevitability of such cases by means of constructing strict mathematical models or game models which may be regarded as a significant defect in field of "audit quality premiums" research; lastly, in the empirical researches on "audit quality premiums", most scholars merely consider the unilateral impact on audit pricing caused by audit quality, which means they only studied the problem about systematic difference of audit fees between famous audit firms such as "Big Four" and other firms, while nearly nobody notice the potential contra-impact on the option tactic of audit quality caused by audit pricing level on the opposite point of view, so it is easy to neglect the complex relationship between audit quality and audit pricing, which is cause-and-effect and endogenous in nature, and this unilateral approach will lead the research into model misspecification inevitably.Considering the disadvantages of previous researches, I probed into the topic on "audit quality premiums" with new angles of view and further systematic approaches. This article is to prove and verify the arising inevitability of "audit quality premiums" and its existing objectivity in our audit market by constructing several theoretical and empirical models. Below are general outlines and conclusions:Chapter 1 is the introduction, covering the motives of this article, the theoretical and practical significance of researches on "audit quality premiums", and reviewing the domestic and international research status of this theme briefly at the same time.The second chapter is the basic theories part which mainly introduced some conceptions and theories relative to "audit quality premiums" closely.The third chapter is an independent and necessary part of empirical research. I selects the earnings management intensity of auditees as the scale index of audit quality and probed the audit quality difference between famous universal accounting companies and those of China by means of t-test, Mann-Whitney U test, sole-variable relativity test and multi-variable regression test for independent samples. All results show the fact that the audit quality of "Big Four" in China is prominent higher than that of others. Furthermore, I probed the specific reasons of different earnings management levels in different types of accounting companies in the same regression model in ways of divided the earnings management motivation into opportunistic motive and informative delivering motive, viz. the influence pathes on eanings management level (audit quality) caused by brand (size) of audit firms. The empirical results disclosed that high-quality accounting companies ("Big Four") can be able to restrict the opportunistic actions of management obviously compareh to others, but it can't change the common negative undone status of informative earnings management. General speaking, the reason why high-quality auditors being able to restrict the earnings management level for customers is that the strong supervisal provided by them can generate the negative impact of increment to managent gambling actions.Though chapter 3 is not focus on the forming mechanism and empirical test of audit quality premiums, instead to answer the questions such as whether "Big Four" can stand for high-quality audit and etc., the theme of this chapter together with its test is very crucial for the conclusion's robustness verified by empirical approach. The index of "brand of accouting companies" which will help decrease the acquirement cost is proved to evaluate the audit quality effectively after the empirical analysis in this chapter, which can be defined as a scientific and economical substitute variable for audit quality in the simultaneous equations models in chapter 6, contributing to enhancing the reliability and stability of empirical test for audit quality premiums.Essential research on "audit quality premiums" is coming after the completion of basic theories (Chapter 2) and substitute variable selection (Chapter 3).In Chapter 4, I built a simple mathematical and econometric model to forecast the relationship between audit quality and audit fees from the view of considering audit service suppliers (auditors) as "economical individual" who have the motivation to realize the personal maximizing benefit. The result concluded from the model shows that different audit firms with different quality levels have different preferred pricing tactic which is that the higher audit expenses together with the higher audit quality, on the contrary, the lower audit expenses together with the lower audit quality, which is the theory basic of existence assumption for "audit quality premiums". In Chapter 5, a new audit price signal game is setup. Through some analysis by the game analytical model PBE, I found that high-quality auditors and low-quality auditors will adopt different tactics which will cause separating equilibrium after auditors and customers performing a series of complex games on audit price, viz. high-quality auditors will charge high price and low-quality auditors will charge low price. This game model takes not only the gain of auditor suppliers (auditors) and the pricing decision rooted from it but also the benefit function of the other key party - audit customers as role of demander into account, both are included into the game model, which remedies the significant defects of the econometric model in Chapter 4 that neglecting the exchange pricing relations between two parties of supplier and demander, so it offer a more complete and powerful support for the rationality and inevitability of the existence of audit quality premiums.After finishing the selection of the agent variables of audit quality (see chapter 3) and the theoretical approving of the rationality of audit quality premiums, I testified the objectivity of audit quality premiums in chapter 6. When processing the empirical test, I sufficiently took the endogenous relationship between audit quality and audit fees into account. Based on this consideration, I constructed a bran-new simultaneous equation model (SEM), apparently, the construction of SEM is an important innovation comparing with the single equation model that was used frequently in the past. After finishing the test of the model by using 2SLS, I finally found that not only audit quality would impose on audit fees positively, but also, the increasing of audit fees would probably induce an optimum selection of audit quality. The conclusions indicated that there must be an endogenous relationship between audit quality and audit fees. In all, the empirical test of chapter 6 told us: In China, audit quality premiums is an objective economic phenomenon.In chapter 7, I made a conclusion of this essay and done some expectations about the future research. The innovations of this essay are below:1. When it comes to the equivalence of audit firms'brand and audit quality (see chapter 3), I constructed a more veracious model to estimate the level of discretionary accruals, furthermore, I found the ways audit quality impose on earnings management for the first time by decomposing the motivations of earnings management.2. By reference of Simunic et al.(2006), I constructed a mathematical model about audit quality premiums. The innovation of this model is that I firstly educed the precondition of the owners when they decided to invest in the continuous projects. This is an important development comparing with Simunic's model.3. I introduced the approach of Perfection Bayesian Equivalent to the area of audit quality premiums for the first time. Moreover, I constructed a bran-new audit pricing signal game model based on the above analysis. By analyzing the payment functions and behavior strategic of the participants of the game, I found another rational theoretical explanation about the phenomenon of audit quality premiums.4. Before I tested the objectivity of audit quality premiums, I sufficiently took the endogenous relationship between audit quality and audit fees into account. Based on this consideration, I constructed a bran-new simultaneous equation model that might reflect the economical essence more efficiently, apparently, the construction of SEM is an important innovation comparing with the single equation model that was used frequently in the past. Furthermore, I adopted the unusual methods of Hausman Test and Two Stage Least Square (2SLS) to testified the SEM, and these two useful approaches might help me obtaining a more scientific and rational conclusion.