The determinants of the UK Big Firm premium

Abstract

Our study attempts to determine whether, and if so why, the large auditing firms are able to earn a premium on their audit work in the UK. We start by confirming the apparent existence of a Big Firm premium during the period 1985-2002. We examine industry specialisation, non-audit service fee and monopoly pricing explanations for the premium. The results of our tests of industry specialisation are mixed. There is little evidence that this premium is associated with industry specialisation when specialists are defined at the national level. Significant premia are observed if specialisation is defined at the city level, particularly if the auditor is the industry leader. However, when appropriate allowance is made for endogeneity, by modelling both audit and non-audit fees in a simultaneous equations framework, the Big Firm premium disappears. We find evidence to suggest that non-audit fees earned by auditors from their audit clients are positively related to the size of the audit fee and vice versa. Finally, when the sample is stratified by the size of audit client, we find no systematic evidence of anti-competitive pricing.