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JAEE
4,2

Audit pricing and product


differentiation in small private
firms: evidence from Thailand

240

Mahbub Zaman and Jaravee Chayasombat


Manchester Business School, University of Manchester, Manchester, UK
Abstract
Purpose There is limited evidence on how differences in economic environments affect the demand
for and supply of auditing. Research on audit pricing has mainly focused on large client markets in
developed economies; in contrast, the purpose of this paper is to focus on the small client segment in
the emerging economy of Thailand which offers a choice between auditors of two different qualities.
Design/methodology/approach This paper is based on a random stratified sample of small clients
in Thailand qualifying for audit exemption. The final sample consists of 1,950 firm-year observations for
2002-2006.
Findings The authors find evidence of product differentiation in the small client market, suggesting
that small firms view certified public accountants as superior and pay a premium for their services.
The authors also find that audit fees have a positive significant association with leverage, metropolitan
location and client size. Audit risk and audit opinion are not, however, significantly associated with
audit fees. Furthermore, the authors find no evidence that clients whose financial year ends in the
auditors busy period pay significantly higher audit fees, and auditors engage in low-balling on initial
engagements to attract audit clients.
Research limitations/implications The research shows the importance of exploring actual
decisions regarding audit practice and audit pricing in different institutional and organizational
settings.
Originality/value The paper extends the literature from developed economies and large/listed
market setting to the emerging economy and small client market setting. As far as the authors
are aware, this is the first paper to examine audit pricing in the small client market in an emerging
economy.
Keywords Emerging markets, Small firms, Audit fees, Audit pricing
Paper type Research paper

Journal of Accounting in Emerging


Economies
Vol. 4 No. 2, 2014
pp. 240-256
r Emerald Group Publishing Limited
2042-1168
DOI 10.1108/JAEE-02-2012-0011

1. Introduction
Despite the growing body of literature on auditing, and particularly on audit pricing,
there is little evidence to indicate institutional or market-specific factors being
addressed in a systematic way, especially in emerging economies (Cobbin, 2002). In a
meta analysis of audit fee studies, Hay et al. (2006) suggest that research investigating
how a firms governance and the regulatory environment that the firm operates in
affect the market for audit services and the fees that the external auditor charges could
be particularly useful. Our understanding of audit pricing in emerging economies, in
which the small client market dominates the market for audit services, is very limited
(see e.g. Ahmed and Goyal, 2005; Yatim et al., 2006; Naser and Nuseibeh, 2007;
Al-Harshani, 2008). Since the seminal work of Simunic (1980) there have been more
than a hundred studies carried out in several institutional settings. However, most
The authors are grateful for comments from Claus Holm, Mohammed Hudaib, Robert Knechel,
Thomas Riis Johansen, Lasse Niemi, Frank Thinggaard and Marleen Willekens on earlier
versions of this paper.

research has focused on the large client market of public listed companies[1]. We are
not aware of any published academic research on audit pricing in small client market of
audit markets in emerging economies.
This paper provides evidence on audit pricing and product differentiation associated
with auditor reputation in the emerging economy of Thailand in which small clients can
choose between auditors of differential quality. Specifically, we test the effect of the
following on audit fees first, product differentiation arising from a choice between
higher and lower quality auditors; second, the existence of agency costs arising from the
firm-debtholder relationship which is a notable feature in the small client market of
Thailand; and finally, metropolitan location of the audit client and the associated high
costs of living in such location. We focus on audit pricing in the Thai small client market,
which constitutes the majority of the economy, and in 2009 accounted for about 99.8 per
cent of firms registered with the Department of Business Development (DBD), Ministry of
Commerce. In contrast, o500 companies are listed on the Stock Exchange of Thailand.
Consistent with usage in developed countries, we use firm size to define small clients.
In the Thai context, this is a firm that meets all three of the following conditions:
(1)

registered capital not more than five million Baht;

(2)

total assets not more than 30 million Baht; and

(3)

total revenues not more than 30 million Baht.

A notable feature of the institutional context affecting auditing in the Thai small client
market is a choice to appoint an auditor of a higher (or lower) quality. Regardless of
their size, companies have to submit financial statements to the registrar for financial
reporting purposes and to the tax authorities for tax assessments. Small clients were
exempted from an audit requirement in 2002, however, for tax returns purposes their
accounts must be audited either by a certified public accountant (CPA) or by a tax
auditor (TA), a newly introduced qualification. The Thai context thus allows us to
examine the effect of auditor reputation, associated with the choice of a CPA or TA,
in the small client market[2]. We test if employment of an audit firm with an above
average reputation results in an observable difference in audit fees. Moizer (1997) notes that
individual firms have an economic incentive to incur above average costs in order to
produce a service of above average quality because eventually customers will recognize this
improved quality and be prepared to pay higher audit fees. The differences between the
CPA and the TA qualification imply that there will be a perceived difference in audit quality
that might be reflected in audit fees. In Thailand the prerequisites for the CPA qualification
are: first, a suitable academic degree in accountancy with at least eight compulsory
accounting and auditing courses; second, three years of work experience (minimum 3,000
hours) under the supervision of a CPA; and third, satisfying audit examination on seven
subjects. In contrast, TAs need to have a suitable academic degree in accountancy and
must pass three exams. Unlike CPAs, TAs are not required to have work experience in
auditing. While the Federation of Accounting Profession supervises CPAs, the Bureau
of Tax Auditing Standards (BTAS) supervises TAs. The BTAS issues guidelines for the
audit of small clients to be followed by both CPAs and TAs. The TA qualification has
existed since 2001 whereas the CPA qualification has existed since 1962 in Thailand.
The differential qualities of the CPA and TA in the small client market enable us to examine
the effect of auditor reputation on audit fees in an emerging economy context.
Focusing on market-specific factors and paying particular attention to the
institutional setting in which small client audit is conducted our paper seeks to extend

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prior research mainly conducted in developed economies. There is a growing interest in


the impact of market-specific variables on audit pricing. For example, GonthierBesacier and Schatt (2007) and Thinggaard and Kiertzner (2008) examine the effect of
joint auditing process in France and Denmark, respectively. Clatworthy and Peel (2007)
consider the UK corporate structure in the quoted sector and in the unquoted sector
and find evidence of a fee premium. Choi et al. (2008, 2009) take into account the legal
environment in examining the effects of cross-listings on audit fees and find that fee
premiums are associated with increased legal liability of auditors in the cross-listed
foreign country. Niemi (2004) examines the association between auditors technical
capability and hourly billing rate of the small firm auditors and reports that these
factors are very significant in the market for audit services in Finland. These studies
conducted in developed economies illustrate that market-specific factors have significant
impacts on audit fees. There are differences in the market for audit services between
listed and private firms and between developed and emerging economies (Karim and
Moizer, 1996; Cobbin, 2002; Hay et al., 2006). Despite their significance to the economy,
there is limited evidence on audit pricing in the small client market in emerging
economies[3]. Market-specific studies thus have the potential to contribute to better
understanding of audit pricing in different economies.
For small clients in the emerging economy of Thailand we find evidence of a fee
premium for CPAs, consistent with product differentiation, suggesting that small
clients view CPAs as superior in terms of perceived quality and pay a premium for
their services. As the financial market for small Thai private firms is bank oriented,
agency costs resulting from the firm-debtholder relationship is positively associated
with audit fees. We also find audit clients located in the metropolitan centre, Bangkok,
pay a fee premium. While we find that firm size is significantly associated with audit
fees, we do not find evidence of audit opinion or client risk having a significant
association with audit fees. Our additional analysis shows that audit fees for small
clients is not significantly associated with the existence of agency costs between
government and firms arising from the high alignment between financial reporting
and tax reporting. In addition, clients whose financial year ends in the auditors busy
period do not pay significantly higher audit fees. Furthermore, we find no evidence
that auditors engage in low-balling on initial engagements to attract audit clients.
The remainder of this paper is organized as follows. The next section develops the
hypotheses and explains the audit fee model. Section 3 reports the empirical findings
and results of additional tests. Finally, Section 4 concludes the paper with a summary
of main findings and suggestions for future research.
2. Hypotheses, model development and data
Fee premiums on perceived audit quality
Research conducted in developed economies suggests that there is a fee premium
associated with audit quality. Although audit quality may be measured using various
surrogates, such as auditor reputation, audit firms organizational form, industry
expertise and audit firm size (see e.g. DeFond, 1992; Fargher et al., 2001; Hua-Wei et al.,
2007), the most common variable used in the audit fee literature is a dummy variable of
Big N and non-Big N audit firms (Hay et al., 2006). As Big N audit firms are perceived to
be high quality corresponding to these surrogates, we expect their audit services to be
sold at a premium. Moizer (1997) notes four possible explanations for the Big N premium:
(1)

the Big N audit to a higher standard and expend more resources in the conduct
of the audit;

(2)

(3)
(4)

the Big N have established reputation for performing higher quality audit and
the premiums reflect greater confidence felt by readers of audited financial
statements;
auditors represent a form of insurance protection for an otherwise uninsurable
business risk; and
the premium relates to the level of oligopoly enjoyed by the Big N.

Studies conducted in publicly listed client market provide evidence that Big N audit
firms earn a fee premium[4]. The evidence on product differentiation in the private
client market is, however, ambiguous. Brinn et al. (1994) and Chaney et al. (2004) do not
find evidence of a fee premium for Big N auditors for the private UK firms. In contrast,
Clatworthy and Peel (2007) and Van Caneghem (2010) find product differentiation
between Big N and non-Big N audit firms for the large UK and Belgium private firms,
respectively. Similarly, in their study of small unquoted UK companies Peel and Roberts
(2003) find that mid-tier auditors charge a premium. Niemi (2004) also finds evidence of
product differentiation among small Finnish audit firms.
In the Thai context, small firm auditors initially invest in their reputations via
certifications from either of the two different professional societies. Because the CPA
qualification requires more training, education and examinations than the TA
qualification, we consider CPA auditors invest more in their reputations. When actual
product quality is difficult to observe prior to purchase, supplier reputation serves as a
signal of superior quality (Shapiro, 1983; Niemi, 2004). Due to the perceived higher
quality associated with the CPA qualification, we expect CPAs to earn fee premiums in
the Thai small client market. Our first hypothesis is thus:
H1. Ceteris paribus, there is a positive association between having a CPA as an
auditor and small client audit fees.
Bank-oriented financial systems
Private firms are typically closely held, and their financial statements are not widely
distributed to the public (Van Tendeloo and Vanstraelen, 2008). Thai small clients operate
in a bank-oriented system and thus the primary users of their audited accounts are lenders.
Since auditors facilitate the principal-agent relationships between firms and lenders, some
part of the audit fee may account for agency costs (Hay and Davis, 2004). Prior studies
have used leverage as a proxy for agency costs of debt (e.g. Francis and Stokes, 1986; Low
et al., 1990; Gregory and Collier, 1996; Karim and Moizer, 1996; Lee, 1996; DeFond et al.,
2000; Willekens and Achmadi, 2003; Clatworthy and Peel, 2007; Thinggaard and
Kiertzner, 2008; Van Caneghem, 2010). The demand for monitoring is likely to increase
with leverage (Hay and Davis, 2004), as the riskiness of the client increases, and be
reflected in higher audit fees. Meta analysis nonetheless shows that many studies have
not found a significant relationship between leverage and audit fees (Hay et al., 2006).
Following DeFond et al. (2000) and Abbott et al. (2003) we proxy for agency relationship
between the firm and debtholders using leverage. Our second hypothesis is thus:
H2. Ceteris paribus, there is a positive association between leverage and small client
audit fees.
Metropolitan location of audit clients
Prior evidence suggests that audits conducted in metropolitan locations, where
costs are generally higher than in the rest of the country, might affect audit pricing

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244

(Hay et al., 2006). In developed markets the impact of client location has been examined
in counties with such a centre, for example, London (Brinn et al., 1994; Peel and
Roberts, 2003; Chaney et al., 2004; Clatworthy and Peel, 2007), Oslo (Firth, 1997) and
Helsinki (Niemi, 2004). In the Thai context, we expect that audit clients located in the
metropolitan centre of Bangkok where costs are generally higher than in the rest of
the country will pay more for their audits than those in non-metropolitan locations.
Our third hypothesis is thus:
H3. Ceteris paribus, there is a positive association between an audit client being
located in a metropolitan location and small client audit fees.
Control variables
In testing the hypotheses outlined above, we control for a number of variables that
might influence audit pricing, i.e. client size, client complexity, auditor risk and audit
opinion.
Client size. Prior research suggests that there is a relationship between audit pricing
and client size (Hay et al., 2006). The majority of audit fee studies use total assets as a
measure of client size while some use total revenues (Chan et al., 1993; Hay et al., 2006).
An audit of transactions may be related to turnover while verification of assets may be
associated with total assets (Pong and Whittington, 1994). Following Peel and Roberts
(2003), we include both size variables in our audit fee model. In order to improve the
linear relationship with audit fees, we use the natural logarithm of total assets and total
revenues (see Hay et al., 2006).
Client complexity. Audit examination tends to be harder and more time-consuming
when a client is more complex (Simunic, 1980). Thus, audit fees tend to increase with
complexity. A number of studies in the UK (Pong and Whittington, 1994; Chaney et al.,
2004), Denmark (Thinggaard and Kiertzner, 2008), Australia (Francis and Stokes,
1986), Hong Kong (Ho and Ng, 1996; Lee, 1996) and cross-countries (Fargher et al., 2001;
Chung and Narasimhan, 2002; Fan and Wong, 2005) find a positive relationship
between audit fees and complexity measures. Complexity is mainly proxied using the
number of subsidiaries. However, small clients are often incorporated as a single
business unit and thus similar to Chaney et al. (2004) we use asset turnover as a
measure of complexity[5].
Auditor risk. The inherent risk is the risk associated with the verifiability of
financial statement items by an auditor (Thinggaard and Kiertzner, 2008). Receivables
and inventories are typically risky balance sheet components requiring specific
auditing procedures (Simunic, 1980). As the information on receivables and inventories
is not available in Thai small clients abbreviated accounts, we use total current assets
as a proxy for inherent risk. Another common measure of audit risk is client profitability
as it reflects an expected share of losses when there is significant deterioration in clients
operations (Simunic, 1980; Fargher et al., 2001). The worse the performance of the firm,
the higher the exposure of the auditor and the higher the audit fee (Hay et al., 2006).
We thus control for a clients accounting rate of return in the current year.
Audit opinion. Hay et al. (2006) find that only 13 out of 46 studies (28 per cent) found
the expected positive relationship between audit fees and audit opinions. In the
emerging economy of Thailand, the nature of audit opinions may be an important
driver of audit fees because modified audit reports could send negative signals to
lenders and tax authorities. The circumstances giving rise to a modified opinion may
signal the need to increase the level of assurance and consequently the cost of an audit.

A modified opinion is usually issued after the auditors have undertaken additional
work and accumulated a greater amount of evidence (Palmrose, 1988; Clatworthy and
Peel, 2007). We thus control for audit opinion in our audit fee model.
Audit fee model
We formulate an audit fee model based on our consideration of Thai specific factors
and control variables discussed above. Our model thus tests how audit pricing in the
emerging economy of Thailand is affected by: first, product differentiation arising from
a choice between higher (CPA) and lower (TA) quality auditors; second, the existence of
agency costs arising from the firm-debtholder relationship which is a notable feature in
the Thai small client market; and third, a metropolitan location of the audit client and
the associated high costs of living in such location. We estimate the following
multivariate regression:
ADTFEEit b0 b1 CPAit b2 LEVit b3 METROit b4 REVit b5 ASSET
b6 ATOit b7 CURRAit b8 ROAit b9 ADTOPINit fixed effects eit

where ADTFEEit is a continuous variable of the natural logarithm of audit fees. CPAit
is a dummy variable of the actual auditor choice to test for product differentiation
(H1). The firm-debtholder relationships (H2) are proxied by the ratio of long-term debt
to total assets (LEVit). METROit (H3) is a dummy variable to test for the effect of
metropolitan location of audit client on audit fees. Client size is measured using the
natural logarithm of both total revenues (REVit) and total assets (ASSETit). Asset turnover
(ATOit) is included as a proxy for small-client complexity. The ratio of current assets to
total assets (CURRAit) and the return on assets (ROAit) are proxies for audit risk.
Finally, ADTOPINit is a dummy variable to test for the effects of audit opinion on audit
fees. Table I presents a full description of these variables and their predicted signs of
association with audit fees.
Data and sample selection
All registered companies in Thailand are required to file financial statements with the
DBD of the Ministry of Commerce. We obtained hand-collected data for our paper from
the Ministrys official archive that contains financial statements and audit reports for
Thai registered companies. From the list of all registered Thai companies we found
that approximately 67,800 firms out of about 280,000 are active small firms qualifying
for the audit exemption under the Ministerial Regulation Audit Exemption, B.E. 2544
(A.D. 2001).
To account for potential industrial and geographical biases we used a stratified
random sample with industry sectors and the government standard regions as
stratifying variables[6]. This resulted in 700 small-sized firms with available financial
data and audit information. To control for unobserved characteristics of firms and to
allow for the analysis of lags in variables we constructed panel data consisting of a
time series for each of the cross-sectional firms in the data set. DeFond (1992) suggests
that the link between audit quality and agency conflicts may depend on the time-period
over which the agency variables are measured. The inclusion of panel data from 2002
to 2006 in this paper reduces potential bias from the specific period selected for the
study. After eliminating missing data, the final sample consists of 1,950 firm-year
observations from 2002 to 2006. The next section provides descriptive statistics relating
to our audit fee model and results of multivariate tests and additional analysis.

Audit pricing
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245

JAEE
4,2

Variable

Label

Description

ADTFEEit The natural logarithm of total audit fees


at year t
Auditor quality
CPAit
1 when the auditor is a CPA at year t, and
0 otherwise
Long-term debts divided by total assets at
Firm-debtholder relationship LEVit
246
the end of year t
Audit client location
METROit 1 when the location of an audit client is
Bangkok, and 0 otherwise
The natural logarithm of total revenues at
Client size
REVit
the end of year t
The natural logarithm of total assets at
Client size
ASSETit
the end of year t
Asset turnover, calculated as total
Complexity
ATOit
revenues divided by total assets at the end
of year t
Audit risk (inherent risk)
CURRAit
Current assets divided by total assets at
the end of year t
Return on asset, calculated as net income
Audit risk (profitability)
ROAit
divided by total assets at the end of year t
Audit opinion
ADTOPINit 1 when a firm received modified opinion in
the current year (year t), and 0 otherwise
Table I.
fixed effects Dummy variables controlling for fixed
Descriptions of variables
effected of calendar years and industries
and expected relationships
eit
Error terms at year t
with audit fees

Expected sign

Audit fees

3. Empirical results
Descriptive statistics and correlations
Table II reports descriptive statistics for the whole sample. The CPAs comprise 66
per cent of the sample CPAs have 1,286 and TAs have 664 clients. The mean audit fee
of the sample firms is 6,654 Baht and ranges from a minimum of only 1,000 Baht to a
maximum of 40,000 Baht[7]. The difference in audit fees is relatively large, suggesting
that product differentiation takes place among the sample auditors (Niemi, 2004).
The average total revenues of the sample firms is approximately five million Baht, the
mean total assets is much lower at 2.8 million Baht. In comparison, in their audit-fee
study of the UK micro-firms, Peel and Roberts (2003) report mean sales revenue and
total assets of 801,854 and 471,861, respectively. Firms in our sample are substantially
smaller than the ones in prior studies conducted in developed markets. Concerning the
principal-agent relationship variable, the sample firms have an average long-term debt to
total assets (LEV) of only 17.2 per cent. In terms of audit risk measures, the mean current
assets to total assets (CURRA) is almost 0.7 times and the average return on assets (ROA)
is lower than 0.11 times. The table also reveals that only 17.9 per cent of the sample
received modified opinions (ADTOPIN), and almost 40 per cent of the sample are located
in the metropolitan (METRO) centre.
Table III presents the correlation matrix for the explanatory variables used in our
audit fee model[8]. Most of the correlations are relatively low. As expected, the
correlation between both size measures (REV and ASSET) is relatively large (62.3 per
cent) compared to the one reported for small auditees in Peel and Roberts (2003, p. 223)
study (36 per cent). None of the correlation coefficients is above 70 per cent, thus
multicollinearity is not a problem (Kervin, 1992; Anderson et al., 1999). In terms of the

Variable
ADTFEE
Audit feesa
CPA
LEV
METRO
REV
Total revenuesa
ASSET
Total assetsa
ATO
CURRA
ROA
ADTOPIN

Mean

SD

Min.

Max.

1,950
1,950
1,950
1,950
1,950
1,950
1,950
1,950
1,950
1,950
1,950
1,950
1,950

8.697
6,654
0.659
0.172
0.374
14.615
4,996,722
14.282
2,825,105
2.791
0.692
0.105
0.179

0.465
3,340.087
0.474
1.292
0.484
1.577
5,807,917
1.179
3,189,347
6.619
0.343
0.265
0.384

6.908
1,000
0
0
0
5.699
298.640
8.487
4,850
0.001
0.001
0
0

10.597
40,000
1
50.103
1
17.212
29,800,000
17.113
27,000,000
221.308
1
8.854
1

Notes: ADTFEE, the natural logarithm of total audit fees at year t; CPA, 1 when the auditor is a CPA
at year t, and 0 otherwise; LEV, long-term debts divided by total assets at the end of year t; METRO,
1 when the location of an audit client is Bangkok and 0 otherwise; REV, the natural logarithm of total
revenues at the end of year t; ASSET, the natural logarithm of total assets at the end of year t; ATO,
asset turnover, calculated as total revenues divided by total assets at the end of year t; CURRA, current
assets divided by total assets at the end of year t; ROA, return on asset, calculated as net income
divided by total assets at the end of year t; ADTOPIN, 1 when a firm received modified opinion in the
current year (year t), and 0 otherwise. aThe statistics for Audit fees, Total revenues and Total
assets are in Thai Baht

1. ADTFEE
1
2. CPA
0.140*** 1
3. LEV
0.204*** 0.074*** 1
4. METRO
0.093*** 0.144*** 0.097***
5. REV
0.312*** 0.060*** 0.084***
6. ASSET
0.233*** 0.017
0.121***
7. ATO
0.148*** 0.064*** 0.005
8. CURRA
0.058**
0.052** 0.153***
9. ROA
0.044*
0.067*** 0.107***
10. ADTOPIN 0.054** 0.081*** 0.050**

Audit pricing
and product
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247

Table II.
Descriptive statistics
of variables in the
audit fee model

10

1
0.057**
1
0.048**
0.623*** 1
0.000
0.589*** 0.183*** 1
0.040*
0.058** 0.146*** 0.055**
1
0.069*** 0.344*** 0.001
0.441*** 0.005 1
0.138*** 0.022
0.036
0.003
0.015 0.061*** 1

Notes: n 1,950. ADTFEE, the natural logarithm of total audit fees at year t; CPA, 1 when the auditor is a CPA at
year t, and 0 otherwise; LEV, long-term debts divided by total assets at the end of year t; METRO, 1 when the
location of an audit client is Bangkok, and 0 otherwise; REV, the natural logarithm of total revenues at the end of
year t; ASSET, the natural logarithm of total assets at the end of year t; ATO, asset turnover, calculated as total
revenues divided by total assets at the end of year t; CURRA, current assets divided by total assets at the end of year
t; ROA, return on asset, calculated as net income divided by total assets at the end of year t; ADTOPIN, 1 when a
firm received modified opinion in the current year (year t), and 0 otherwise.***,**,*Significance at the 0.01, 0.05 and
0.1 levels, respectively (two-tailed test)

Thai context specific variables as discussed earlier (H1-H3), audit fees are positively
correlated with perceived auditor quality (CPA), leverage (LEV) and metropolitan
location (METRO) at 14, 20.4 and 9 per cent, respectively. Thus, correlation tests
confirm three of our hypotheses.

Table III.
Spearmans rank order
correlation coefficients
of variables in the
audit fee model firm-year
observations

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248

Multivariate analyses
Table IV reports the results of the OLS estimation of the audit fee model for the panel
data in the first column and separate regression estimates for the CPA and TA subsamples in the next columns. In the regression for panel data, we estimated NeweyWest standard errors to account for possible autocorrelation and heteroscedasticity
(Heckman, 1978). The F-values and their significance in all models indicate that they
are successful in explaining some of the variance in audit fees. In studies of small
clients the goodness-of-fit of the audit fee model tends to be lower than those of large
clients (see Chan et al., 1993; Peel and Roberts, 2003; Thinggaard and Kiertzner, 2008).
For relatively small-sized firms, this low explanatory power could be due to the
possibility that the audit pricing for small firms is more complex to model or less
responsive to size changes (Peel and Roberts, 2003). The adjusted R2 of 0.13-0.15 in our

Variables

Exp.
Sign

Full sampleb
Coeff.
t

CPA (CPA 1)
Coeff.
t

TA (CPA 0)
Coeff.
t

ADTFEEit b0 b1 CPAit b2 LEVit b3 METROit b4 REVit b5 ASSET b6 ATOit


b7 CURRAit b8 ROAit b9 ADTOPINit fixed/ effects eit
CPA (H1)
LEV (H2)
METRO (H3)
REV
ASSET
ATO
CURRA
ROA
ADTOPIN
Constant
Fixed effectsc
Year
Industry
n
F
Adj. R2

Table IV.
OLS regression estimates
for the audit fee modela

0.074
0.024
0.110
0.066
0.059
0.000
0.024
0.008
0.032
7.012

3.31***
1.69*
5.11***
6.98***
4.69***
0.17
0.81
0.34
1.21
24.61***

Included
Included
1,950
319.30***
0.13

0.019
0.090
0.069
0.061
0.000
0.029
0.016
0.055
7.209

1.89*
3.42***
6.20***
4.31***
0.00
0.81
0.35
1.53
29.78***

Included
Included
1,286
378.20***
0.12

0.110
0.160
0.059
0.057
0.001
0.008
0.004
0.004
6.134

3.12***
3.76***
3.31***
2.38**
0.07
0.15
0.18
0.10
24.46***

Included
Included
664
96.81***
0.15

Notes: ADTFEE, the natural logarithm of total audit fees at year t; CPA, 1 when the auditor is a CPA
at year t, and 0 otherwise; LEV, long-term debts divided by total assets at the end of year t; METRO, 1
when the location of an audit client is Bangkok, and 0 otherwise; REV, the natural logarithm of total
revenues at the end of year t; ASSET, the natural logarithm of total assets at the end of year t; ATO,
asset turnover, calculated as total revenues divided by total assets at the end of year t; CURRA, current
assets divided by total assets at the end of year t; ROA, return on asset, calculated as net income
divided by total assets at the end of year t; ADTOPIN, 1 when a firm received modified opinion in the
current year (year t), and 0 otherwise; fixed effects, dummy variables controlling for fixed effected of
calendar years and industries; eit, error terms at year t. aThe regressions are estimated using ordinary
least squares, and t-statistics are based on Newey-West standard errors. bThis column reports results
based on the full sample while those in the next two sets of columns are based on sub-samples divided
by auditor choices, where CPA 1 and 0, respectively. cFixed effects are included in regression as
specified but for simplicity, their results are not reported. ***,**,*Significance at the 0.01, 0.05 and 0.1
levels, respectively (two-tailed test)

paper compares well with Peel and Roberts (2003) who reported an adjusted R2 of 0.12
for their study conducted in the developed market of the UK.
The actual auditor choice variable (CPA) included in our audit fee model is significant
( po0.001) and positive as expected. In line with our first hypothesis, the positive
coefficient of CPA indicates a fee premium based on the superior reputation of CPAs.
Since any auditor can satisfy statutory audit requirements, the voluntary decision to
appoint a higher-priced auditor implies that a differentiated product is associated with
that auditor (Francis and Stokes, 1986). Our findings provide evidence that fee premiums
also exist in the small client market. The finding is consistent with that for developed
economies[9].
Consistent with our expectations we find support for our second hypothesis. The
agency cost variable LEV is moderately significant ( p 0.092) and positive. For the
TA sub-sample, however, LEV is highly significant at p 0.002 level. As expected,
these findings suggest that leverage plays a role in audit pricing of small clients in
Thailand. In comparison, Fan and Wong (2005) found that leverage is insignificant
in audit pricing of Big 5 audit firms for their sample of 233 listed companies in
Malaysia and so did Thinggaard and Kiertzner (2008) for their sub-sample of small
public companies in Denmark. We find support for metropolitan location hypothesis
in the emerging economy of Thailand. This is consistent with previous studies in
developed markets (Chan et al., 1993; Brinn et al., 1994; Beattie et al., 2001; Peel and
Roberts, 2003). Our audit fee model shows that small firms located in the metropolitan
centre (Bangkok) pay an audit fee premium. The fee premiums may be due to the high
cost of living in such a centre of the country (Peel and Roberts, 2003). The coefficient is
positive and highly significant at po0.001 level.
Of the control variables, only the client size measures are statistically significant.
Both size variables REV and ASSET are highly significant (both at po0.001 level) and
positive, consistent with our expectation that fees are higher for larger firms. None of
the complexity and audit risk variables are statistically significant a finding
consistent with that of Peel and Robertss (2003) UK micro-firms study and Camerans
(2005) large Italian private-firms study. The insignificance of the audit risk variables
could be due to the fact that small firms are generally perceived to be risky to start with
Thinggaard and Kiertzner (2008). Correspondingly, audit risks and complexity do not
appear to be important in audit pricing for small firms in emerging economies whereas
they are for large firms in developed economies[10]. Contrary to our expectations,
ADTOPIN is negatively associated with audit fees for both the full and the CPA
samples. As such, we do not find significant support for the effect of modified opinion
on audit fees.
Overall results from our audit fee analysis show that Thai small clients view CPAs
as superior in terms of perceived quality to justify a fee premium even in a competitive
market. This finding adds to the very scarce evidence on product differentiation in the
small client market. Though displaying some significant results, the effect of agency
costs from the firm-debtholder relationship on audit fees is not strongly significant.
Consistent with the audit fee literature in various markets, our findings suggest that
auditors account for client size in their service charges.
Additional tests
We conducted additional tests to examine the effect of busy season and price-cutting on
initial audit engagements and the firm-tax authority agency relationship on audit fees
in the small client market of the emerging economy of Thailand.

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Busy season. An audit conducted during the busy season may be more costly due to
work overloads (Hay et al., 2006). A number of studies have examined the effect of busy
season on audit pricing (e.g. Craswell et al., 1995; Karim and Moizer, 1996; DeFond
et al., 2000; Peel and Roberts, 2003). In Thailand, 31 December is the most common
financial year-end, and the auditors busy season is from January to April because
audited accounts have to be filed by the end of May. Following prior studies, we
include a dummy variable for a busy season in our audit fees model. The variable is
statistically insignificant. A possible explanation for this might be that there are not
many firms with non-December financial year ends. An examination of the account
year-end of all the sample firms reveals that more than 90 per cent have financial year
ends on 31 December.
Price-cutting. This is a special case of low-balling, a concept describing a relationship
between audit fees and audit costs in which initial audit fees are lower than total audit
costs (Francis, 1984, p. 138). As the Thai audit market for small clients is relatively
competitive, there is a possibility of price-cutting on initial audit engagements in order to
attract clients and start to build auditor-client relationships. In line with Francis and
Simon (1987), we re-estimated the audit fee model with an additional explanatory dummy
variable for an initial engagement. We do not find evidence that first-time audits are
significantly lower in price than continuing engagements. This suggests that auditors
do not engage in price-cutting behaviour. A possible explanation for this is that the level
of audit fees for the Thai small clients is quite low and that after the initial engagement
auditors tend to retain the same level of fees or only increase it slightly in order to reduce
the risk of losing clients.
Taxation. The impact of the firm-tax authority relationship on audit pricing has not
received much attention. Ball and Shivakumar (2005) note that tax considerations may
influence financial statements of private firms. In the Thai context, this issue is
particularly relevant because there is a high alignment between financial and tax
reporting, and small clients statutory audited accounts are mainly used for tax
purposes. We undertook additional test to examine if firms with higher agency costs,
resulting from the firm-tax authority relationship, incur higher audit fees using TAX
as a proxy, measured using the ratio of tax expenses divided by total revenues[11].
Contrary to our expectations, the correlation between audit fees and agency TAX is
negative and insignificant. When we include TAX as an additional variable to our
audit fee model, we find that it has a negative coefficient but is statistically
insignificant. Thus, we do not find significant evidence that auditors charge for higher
agency costs resulting from the firm-tax authority relationship in the Thai small client
market.
4. Summary and conclusions
Our paper extends the literature from developed economies and large/listed market
setting to the emerging economy and small client market setting. As far as we are
aware, this is the first paper to examine audit pricing in the small client market in an
emerging economy. Despite the fact that audit fee studies have been conducted in
various national audit markets, the majority of them are based on large, often listed,
companies. Lately, researchers have shown an increasing interest in the small client
market (see, e.g. Willekens and Achmadi, 2003; Chaney et al., 2004; Cameran, 2005;
Clatworthy and Peel, 2007). These studies, however, are mainly limited to developed
markets. In spite of the importance of the small client market in emerging economies,
we know very little about audit pricing and product differentiation.

This paper examined how audit pricing in the emerging economy of Thailand is
affected by: first, product differentiation arising from a choice between higher (CPA)
and lower (TA) quality auditors; second, the existence of agency costs arising from the
firm-debtholder relationship which is a notable feature in the small client market of
Thailand; and third, a metropolitan location of the audit client and the associated high
costs of living in such location. Our analyses provide evidence of a fee premium for
CPAs, suggesting that small clients view CPAs as superior in terms of perceived quality
and pay a premium for their services. This finding provides evidence of product
differentiation in the small client market. As the financial market for small Thai private
firms is bank-oriented, agency costs resulting from the firm-debtholder relationship are
positively associated with audit fees. Since Thailand is a country with one metropolitan
centre, audit clients located in Bangkok pay a fee premium. We also undertook an
additional analysis of the impact of agency costs between government and firms on audit
pricing. Despite the fact that there is a high financial tax alignment in the small client
market, we do not find evidence that auditors charge for higher agency costs resulting
from the firm-tax authority relationship. In addition, clients whose financial year ends
in the auditors busy period do not pay significantly higher audit fees. Furthermore,
we find no evidence that auditors engage in low-balling on initial engagements to attract
audit clients.
Overall, our paper adds to the knowledge on audit pricing. It extends the literature
from listed/large markets to small client markets and from the context of developed
economies to one of emerging economies. Our paper shows that small clients in
Thailand perceive CPAs as superior in audit quality and pay a fee premium. From a
regulatory perspective, in the Thai small client market, TAs are presumed to provide
the same audit quality as CPAs, and the level of perceived audit quality should be the
same. In practice, however, differences in training, examination and experience
requirements between two tiers of audit qualifications affect auditor reputation in terms
of perceived competence. The voluntary decision to engage a higher-priced auditor,
despite the fact that any certified auditor can satisfy statutory audit requirements,
suggests that a differentiated product is associated with that auditor (Francis and Stokes,
1986). This finding provides evidence of product differentiation corresponding to auditor
reputation in the small client market[12]. In such a context, the established reputation of
the first-tier auditors, i.e. CPAs, signals higher credibility of financial information to the
main users of small client accounts. Key determinants on audit pricing for both CPA and
TA auditors are agency costs resulting from the firm-debtholder relationship, audit
location and client size. Given that CPAs are perceived to be higher-quality auditors than
TAs, regulators need to ensure that quality control has been properly set and enforced in
order to align perceived and actual audit quality. Otherwise, the higher quality perception
of CPAs is likely to fade over time.
Our findings have implications for future research. The core audit fee model
suggested in the auditing literature mainly focused on developing economies is not
very well specified for the emerging economy context. Emerging economies,
particularly those in the same region, share a number of institutional characteristics.
Given the similarity of political, social and economic circumstances prevalent in
particular emerging economies, the findings of our paper may be helpful for future
research in other emerging economies in the South East Asia region and beyond.
Our paper has a few limitations. We relied on data available from the filings with the
Ministry of Commerce. While this has enabled us to examine an important issue,
it has also limited the scope of our paper. Future research should seek to incorporate

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both firm and auditor specific factors, such as ownership and management characteristics,
to obtain better understanding of audit pricing in emerging economies. Surveys may
also be a useful method for capturing such private data, although response rates
may be low due to the nature of small client markets in emerging economies.
In addition, the use of qualitative research offers significant potential for research on
actual decisions regarding audit practice and audit pricing in different institutional
and organizational settings.
Notes
1. See the Appendix for a summary table illustrating the focus of various audit fee studies.
2. Big 4 audit firms exist in Thailand. However, their clients are in the large/medium business
market. Auditors of small clients on the contrary are sole-practitioners or small audit firms.
Our examination of auditor reputation effects is not based on a Big N/non-Big N classification.
Similarly, in the Thai small client market the same auditor is responsible for financial audits
and tax compliance checks. As such, the issue of dual supply of audit and tax services to the
client does not apply here as it often does in other markets. In Thailand accountants are
responsible for the preparation of annual accounts and tax returns, and their fees are separate
from auditors fees.
3. A possible explanation for this scarcity is the limited availability of data. While the majority
listed-company studies use secondary data, often obtained from databases, to model audit
pricing, the study of small private firms is relatively more problematic (Peel and Roberts,
2003). The issue of data collection difficulty on small firm studies is even more problematic in
emerging economies because databases containing financial and accounting information are
not often readily available for small clients.
4. For evidence on developed economies see, for example, Francis and Stokes (1986), Francis
and Simon (1987), Chan et al. (1993) and Johnson et al. (1995). For emerging economies see, for
example, Simon et al. (1992), Dugar et al. (1995), Karim and Moizer (1996), Lee (1996), Simon
and Taylor (1997) and DeFond et al. (2000).
5. Due to limitations of data availability we are not able to explore alternative measures of
complexity.
6. The industry sector is divided into alphabetical groups in accordance with Thailand
Standard Industrial Classification, which is similar to the UK Standard Industrial Classification
of Economic Activities (UK SIC). With regards to regions, there are six official regions according
to the Alphabetical Order of Thai Geography of the Royal Institute; these are Central, North,
North East, West, East and South. As there are a large number of firms operating in Bangkok,
which is the capital city, this province is coded as one region in this paper. In total, the sample
covers seven regions.
7. Approximate exchange rate as of June 2012: 1 50 Baht, and h1 40 Baht (www.bot.or.th).
8. The Spearmans rank order correlation was used instead of the Pearsons correlation as the
data do not meet the stringent assumptions of the latter. We also run the Pearsons
correlation, and results from Spearmans and Pearsons tests are not significantly different.
9. For example the USA and Canada (Anderson and Zeghal, 1994), UK (Chan et al., 1993; Pong
and Whittington, 1994), Australia (Francis and Stokes, 1986), Pacific Rim (Ho and Ng, 1996;
Lee, 1996) and cross-countries (Chung and Narasimhan, 2002), and in the small private-firm
market in developed economies (Peel and Roberts, 2003; Niemi, 2004; Clatworthy and Peel,
2007; Van Caneghem, 2010).
10. Recent studies in developed economies have shown that audit risks and complexity are
significant factors in audit pricing for large companies (Chaney et al., 2004; Clatworthy and
Peel, 2007; Van Caneghem, 2010).

11. Given the requirements for the presentation of annual accounts in the small client market,
the best available proxy for this factor is the ratio of tax expenses to total revenues. This is
not an ideal or very suitable measure. We would have preferred to use deferred tax liabilities,
which is a more appropriate measure, if information was readily available.
12. Our finding is consistent with those of Peel and Roberts (2003) and Niemis (2004) findings
in developed economies and is in line with other studies on the listed audit client market in
emerging economies (e.g. Ho and Ng, 1996; Lee, 1996; Ahmed and Goyal, 2005).
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Appendix
Segmentsb

256

Public listed companies


Large-client

Small-client

Private companies
Large/medium-client

Small-client

Total studies

Table AI.
The number of prior
studies on audit fees
from 1980 to 2009a

Developed markets

USAc
UKd
Australiae
New Zealand
Canada
Ireland
The Netherlands
Francef
Italyg
Norway
Finland
Denmarkh
Japan
Total
USAi
Australiae
UK
Canada
Denmarkh
Total
UKn
Belgiumo
Italyg
Total
UK
Finlandp
Total

Developing/emerging markets

44
22
17
5
2
2
2
1
1
1
1
1
1
100
6
3
2
1
1
13
3
2
1
6
1
1
2

Hong Kong
Indiaj
Malaysiak
Singapore
Pakistanj
Bangladeshj
South Africa
South Korea
Bahrain
Kuwaitl
Jordanm
Nigeria

9
3
4
2
2
2
2
1
1
1
1
1

Total
Hong Kong

29
3

Total

Nilq

Nil

121

32

Notes: aWhen studies reported separate results for individual sample analyses, the partition of each
sample is treated as a separate study in the table. bThese segments are based on client size. cCasterella
et al. (2004), Danielsen et al. (2007), Hoitash et al. (2007), Hua-Wei et al. (2007) and Kealey et al. (2007).
d
Basioudis and Francis (2007) and Clatworthy and Peel (2007). eCarson et al. (2004). fGonthier-Besacier
and Schatt (2007). gCameran (2005). hThinggaard and Kiertzner (2008). iCasterella et al. (2004) and
Hua-Wei et al. (2007). jAhmed and Goyal (2005). kYatim et al. (2006). lAl-Harshani (2008). mNaser and
Nuseibeh (2007). nChaney et al. (2004) and Clatworthy and Peel (2007). oVan Caneghem (2010). pNiemi
(2004). qIn Karim and Moizers (1996) study of audit pricing in Bangladesh, the sample includes large
unlisted companies; however, there is no separate analysis for this
Sources: Adapted from Cobbin (2002), Peel and Roberts (2003), Hay et al. (2006) and further literature
review on audit-fee studies published after Hay et al. (2006)

Corresponding author
Dr Mahbub Zaman can be contacted at: mahbub.zaman@mbs.ac.uk

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