Audit firms are concerned that clients perceive the audit service as a commodity, with little value added, resulting in clients switching to firms that offer lower fees. However, the auditing literature lacks qualitative insight from clients on the reasons that they change audit firms and their perceptions of the value of audit services. To better understand the client's perspective, we conducted interviews with 20 financial managers who participate in audit firm appointment decisions. Our results suggest that the quality of the auditor-client relationship is the key determinant of auditor switching and audit value. Interestingly, price becomes an important factor only when the auditor-client relationship is mismanaged (e.g., when clients perceive that their auditor is not available to them).
As many audit firms are losing clients to competing firms that offer lower audit fees, audit practitioners are concerned about client perceptions of the value of audit services (Reason 2010). We recently visited with two marketing directors of a Big 4 audit firm who expressed concerns about client loyalty because they were losing some of their publicly traded and privately held audit clients to other firms. The marketing directors were interested in the reasons behind this switching behavior and questioned how much of this behavior was attributable to audit pricing, relative to other factors. They also were interested in learning more about what their firm could do to add value to the audit in order to reduce this switching behavior. Similarly, audit standard setters are concerned about the impact of competitive pricing on audit quality (CPAB 2010). These factors motivated us to investigate two main issues: (1) why clients switch audit firms, and (2) what value clients perceive that they receive from audit services.
In the auditing literature, most of the studies that examine the reasons that clients switch audit firms are based on archival or survey data (see Stefaniak et al.  for a review). To our knowledge, no study to date has conducted in-depth interviews to better understand the perspectives of client management concerning the reasons for switching audit firms, as well as their perceptions of the value of audit services. An in-depth interview perspective is important because it provides an opportunity for clients to directly explain their perspectives and provides us with new insights, which are difficult to obtain through other research methods. This is most likely why audit researchers are calling for and conducting more qualitative research related to audit practice and client perspectives to provide additional insights into the behavioral reasons for auditor changes and other issues (Beattie and Fearnley 1998; Bédard et al. 2012).
Researchers also encourage a marketing perspective into audit clients' buying behavior (Beattie et al. 2001). More precisely, the marketing concept of client perceived value might be useful when studying switching behavior because perceived value has been shown to increase client retention (Grönroos 1997, 2001).
Accordingly, we conducted interviews with 20 financial managers who participate in audit firm appointment decisions to explore (1) the reasons that they would switch audit firms, and (2) the value that they perceive that they receive from an audit. For public companies, although the audit committee ultimately is responsible for decisions regarding auditor appointments, our sample participants with public companies informed us that these decisions always involved the financial director (e.g., CFO). The financial director, with or without the approval of the president or owner, forms a team and makes a recommendation to the audit committee, which then takes this recommendation to the board. In all of our cases, the audit committee and board selected the firm recommended by the financial executives and their team. In private companies in which there is no audit committee, financial executives shared the decision making with others, such as owners and presidents. Therefore, our participants strongly influenced the decision-making process for selecting and dismissing firms, regardless of whether the client is public or private.1
Our results indicate that clients are more likely to switch audit firms when they perceive that the audit firm mismanages the auditor-client relationship. Specifically, clients are more likely to switch firms when they perceive that their auditor is not available to them. This aspect of audit service, which we label as “availability,” is a previously unexplored element of value-added audit services. We also find evidence indicating that a close relationship with client management can help audit firms compensate for higher audit fees and extra billings by reducing their importance. Our findings suggest that audit service quality as opposed to audit quality (i.e., detecting and reporting misstatements, see DeAngelo 1981) plays a significant role in audit firm retention decisions.
BACKGROUND AND LITERATURE REVIEW
Auditor Switching Literature
Stefaniak et al. (2009) conducted an extensive review of the auditing literature on the causes and consequences of auditor switching. They reviewed 57 studies that investigate the causes of auditor switching from the client perspective. The majority of these studies use archival data pertaining to publicly listed companies. Only eight studies use survey data, and none of these studies use interviews. The switching studies yield conflicting results. While some find that audit fees are the most frequently cited reason by clients for considering an auditor change (Beattie and Fearnley 1995, 1998; Whisenant 2003; Ettredge et al. 2007; Brazel and Bradford 2011), other studies find that clients change audit firms more because of behavioral reasons (e.g., the auditor-client relationship) than economic reasons (Addams and Davis 1994; Addams et al. 1996; Magri and Baldacchino 2004). In Eichenseher and Shields' (1983) study, clients cited audit fees and their working relationship with the audit firm as the most important reasons to change audit firms.
Client Perceptions of Service Value
None of the switching studies discussed above consider the value that clients perceive that they receive from the audit. The value that clients perceive that they receive from their auditors and the audit service itself likely is important when they are deciding to switch or stay with a firm, as the service marketing literature shows that increased perceived value of a service reduces customer switching behavior (Grönroos 1997, 2001; Paulin et al. 2000). Further, marketing perspectives are encouraged in order to gain new insights into client buying behavior, as economic reasons offer only a partial explanation of buyer behavior (Beattie et al. 2000).
Several studies concerning audit services incorporate the concept of auditors adding value to the core audit service, often referred to as the value-added audit. The value-added audit is an audit that includes additional formal and informal business advice and goes beyond the standard audit service (Eilifsen et al. 2001; Fontaine and Pilote 2011, 2012; Herda and Lavelle 2013a, 2013b). Consistent with the concept of the value-added audit, we draw on the definition of client perceived value theorized in the service marketing literature, where a total service offering (and a client's perceived value) is separated into two components: core value and added value (Grönroos 1997, 2001).
Core value is defined as the benefit of a core solution (i.e., the primary billable service). In the audit context, this entails independent verification and the detection/reporting of misstatements. The added-value component of an overall service experience is created by the additional services provided by the service provider, which can include additional information and even personal attention and support (Grönroos 2001; Crosby et al. 2002). This perspective informed our research methodology.
To investigate why clients switch audit firms and what value they perceive that they receive from the audit, we developed a standardized open-ended interview guide and used this guide in our interviews with financial managers.2 We based our questions on our research objectives and informed by our theoretical framework. In the guide, we divided the questions into three parts: (1) reasons for switching, (2) perceived value of an audit, and (3) participant demographics. We used purposeful sampling, which is recommended when certain criteria for participation is required and when the purpose of the research is an in-depth understanding as opposed to generalization (Patton 2002). Our sample criteria were that each participant must be in a financial management position with a Canadian company (either private or listed) and involved in any decision to hire, retain, and dismiss the audit firm. We stopped data collection after we conducted 20 interviews as saturation had occurred (i.e., responses were becoming overly repetitive) and we had obtained enough information to achieve our research objectives.
Table 1 presents information on the participants and their organizations. Most respondents were CFOs or Directors of Finance. The clients operate in a variety of industries, with 40 percent being publicly traded. This sample provided us with a wide variety of companies, which was our objective. There were no notable differences in our results (reasons for switching and perceived value) with respect to the different participant/organization characteristics, including whether the company was publicly traded. The average (median) tenure of the audit firm-client relationship is 9.95 years (6.5 years), ranging from 1 year to 25 years (untabulated). Of the 20 clients, 11 (55 percent) are audited by Big 4 firms and 9 (45 percent) are audited by smaller audit firms.
In Part 1 (reasons for switching), we inquired about future intentions as opposed to past behavior. We did not particularly target companies that had been involved in a past auditor-switching decision because of the uncertainty about the predictability of past behavior on future behavior. Ajzen (1991) argues that intentions are an effective predictor of future behavior and the role of past behavior on future behavior is debatable. It should be noted that, even though we asked about intentions, a few participants did provide reasons for actual past auditor switching in which they were involved. Regardless, it also is helpful to gain insights from managers who have been in long relationships with their auditor and have not had to initiate a change. Presumably, these insights could shed some light on why a company would maintain a long-term relationship with their auditor. In Part 2, we asked participants five questions to ascertain what they perceive as the value of an audit (e.g., “How would you define excellent audit service?”). In Part 3, we asked several demographic questions to gather information on the nature of the client's business and on the role that the interviewee has in audit firm appointment decisions. To analyze the data, we used content analysis, following the steps recommended by Creswell (2003, 2005) to code the data.
Figure 1 depicts a conceptual model of perceived audit value and audit firm switching behavior.3 Consistent with the concept of client perceived value theorized in the service marketing literature, we expect participants to perceive both the core audit service (i.e., independent verification and validation) and value-added services (e.g., industry expertise, management comments) as valuable. Auditors and clients must collaborate during an audit (Fontaine and Pilote 2011, 2012). Client managers are likely to form perceptions concerning the quality of the auditor-client relationship based on their interactions with auditors. We expect this relationship quality aspect of the auditor-client arrangement to be an important factor that impacts clients' perceptions of service value and switching behavior.
Reasons for Switching
Table 2 presents the results of our discussion with financial managers concerning why they would switch audit firms. Table 2 is separated into first- and second-level answers. The first-level answers are the initial reasons given when we first asked the question, and the second-level answers come from further discussion. Four main reasons for switching emerged from our interviews: audit fees, extra billings, business knowledge, and relationship issues. As presented in Panel A, the most-cited reason involved relationship issues with the audit firm. Even when factors such as audit fees and extra billing were named as reasons for auditor change, further in-depth discussions with participants highlight relationship issues as the primary factor that would motivate the client to seek better pricing. Both Audit Fees and Extra Billings are collapsed into Relationship Issues in Panel B, as we explain below.
Out of the 20 interviewees, four financial managers initially cited high audit fees as the main reason they would change audit firms. Interestingly, when the financial directors of these companies continued talking about audit fees, they stated that issues regarding their relationship with the auditors would accelerate the decision to seek better pricing. In one case, a financial director reflecting on a recent auditor change initially expressed concerns with audit fees and then continued on to express trust issues with the lead partner, which accelerated the decision to change. Relevant excerpts from this interview follow:
The main motivation to change for years has been a question of finance. We were with a Big 4 [firm] and it was very expensive. There is no value added to pay $100,000 versus $60,000 for an audit. It's almost $500,000 over 12 years that we waste.
They still would have switched auditors, but a relationship issue regarding trust caused them to change about a year early:
Our Big 4 firm changed our audit partner and sent us a replacement auditor that we didn't trust. The partner demonstrated to us major confidentiality issues so we lost trust in him. This issue accelerated the process; we would have waited a year before changing.
Similarly, another client interviewee initially cited audit fees as the main factor for a future change:
The main factor would be audit fees. Today there is pressure to reduce audit fees, especially when the company is working in a difficult industry when profitability is questionable. Our first cost line is employees and our second is audit fees, so we get pressure within the company and then we get a second pressure from the audit committee.
However, when the discussion continued, this interviewee expressed that problems with trust would cause the interviewee to look elsewhere:
Obviously the relationships that we build are with the audit partner and the manager who are our two main collaborators. So a breach of trust with either of these two would force us to look elsewhere.
Similarly, another interviewee who first mentioned price as a main reason for a past switch, went on to say that relationship issues would cause them to verify other pricing:
What triggered the process here was the way situations were handled, which led to some uneasiness with the relationship. There was a restatement that had to be done because there was an issue with currency. The auditors dissociated themselves, so it kind of created an “us-and-them” scenario. The approach became adversarial. Then people said, by the way we've been with the same people for 20 years, we should go to market. Then of course what the shocker is, the new guys are bidding 30–40 percent less. How could the incumbent then reduce his price by 40 percent to match? Needless to say that auditor was, in turn, history.
In addition, a fourth client who expressed price as a factor that may cause a possible change also expressed the importance of the relationship with the auditor:
at a certain point, if it's been 20 years that you have been dealing with the same auditor, you want to make sure you are paying a reasonable price for the audit. So price might trigger the process, but it is not the lowest price that we would choose … it's the relationship.
Therefore, even though some clients initially cited audit fees as the main reason that they would switch, further explanations provide some evidence that strong relationships would, at the very least, reduce the negative effect of a perceived high audit price and delay switching. Alternatively, the client may invite the auditor to discuss pricing issues instead of soliciting requests for price quotations, as revealed in the following excerpt:
If you are happy with the auditor and you think you might have an issue with costs, I think you should really be sitting down with the firm and say, look, you know that I don't really want to go to bid. To me, the costs look like they're over the top and here are the reasons. Can we find a way to work to be more efficient? What can you do?
In Table 2, First-Level Answers (Panel A) may be characterized as “first blush” responses. In some cases, subsequent and more in-depth discussion revealed other factors that probably would be more important to the participant in pursuing a change in auditors. These responses are characterized as Second-Level Answers (Panel B). For this reason, we collapsed the four cases with “Audit Fees” as the first-level response into “Relationship Issues” in Panel B.
Other than audit fees, three clients cited extra billings as another economic reason for switching auditors. Rather than being related to the audit itself, it appears that these extra fees were being levied on the clients for the occasional inquiry (e.g., a question on the adoption of a new accounting standard). The clients did not seem bothered by the economic impact of the extra charges themselves, but rather by the way the billings were handled, which damaged their trust in the engagement partner. In fact, the clients would have preferred to pay more fees up front or a lump-sum fee at year-end instead of paying each time that they picked up the phone to call their auditor. They perceived that their auditors cared mostly about money and less about the relationship, as illustrated from the excerpts below from three of the interviews:
Whenever I call my auditor, I get a bill for $1,000. For example, I just purchased homes for an investment and I want to structure the transaction for tax purposes, and for 15 minutes I got a bill for $1,200. In the other businesses that I had, I would say in the audit package when I call, accumulate everything and we will look at it at year-end, not every time I call.
I know that when I make a call I won't get a bill right away … for this I am willing to pay a little more.
I hate getting billed every time I ask a question … but I am willing to pay for value.
We also collapsed Extra Billings into Relationship Issues (see Table 2, Panel B), similar to Audit Fees, because the billing issue really came down to a trust issue. Participants were not concerned about the actual bill, but rather the way that the audit firm handled it.
Five participants cited the lack of business knowledge by junior auditors, seniors, managers, and partners as a reason to switch audit firms. Included in Business Knowledge is knowledge about the client company and knowledge about the industry in which the company operates. The result of a lack of knowledge by the auditor is extra time required by the client to explain business issues. In addition, this extra time is perceived as not only a waste of time for the client, but also a potential reason for cost overruns, resulting in higher than planned audit fees. Related excerpts from two interviewees elaborate on this issue:
We changed from a medium-size firm to a Big 4 firm because the medium-size firm did not have very much experience in the insurance business … so we had to have many discussions with them to explain our processes and to explain to them the different insurance programs and how they worked. We had to spend a lot of time explaining. For example, there were often audits of our past insurance claims, so we had to explain exactly what happened when there was an insurance claim. We had to really explain the total process.
… when they come to do the audit and the juniors don't read the file of the company and have not learned the industry (mining) and they come in every five minutes to ask questions … this is bad quality.
Eight participants directly cited relationship issues (the most frequently mentioned reason) as the reason for switching auditors (see Table 2). A trusting relationship could even make up for high audit fees, as evidenced in this excerpt:
Even if the fees are a little higher, I'm getting all of the other services, and I know I can trust them. I'm willing to pay more for the audit … because anytime I need to make a phone call, they're not going to charge me for a phone call and I know I'm going to have the answer that I want.
Clients also have high expectations for open and frequent two-way communication with the auditor, as is evident from this quotation by another interviewee:
It is important that the relationship that I have as CFO with the audit partner is when we consult each other often … he could tell me if I did something that he was not comfortable with right away … the surprise effect is not desirable.
Moreover, another interviewee provides evidence that open communication in a good relationship could even help mitigate poor service:
With a good relationship we can simply explain why we are not satisfied with the service and we expect that the firm will take action to fix the service.
We also asked participants about how they believed that their audit firms could further add value.4 Four main themes emerged: auditor-client relationship quality, additional advice, validation, and independence (Table 3 provides details). These results provide additional support for the clients' reasons to switch audit firms as discussed above.
Seven participants commented that the actual audit service is a commodity and the differentiating factor is the relationship with the people delivering the audit service. Indeed, a recent academic study points to a trend in the commoditization of financial audits over the last several years (Christensen et al. 2012). Excerpts from two interviewees provide relevant examples of this belief:
It always comes down to individuals … it's the same thing as a bank differentiating itself from another bank … it's individuals … it is the chemistry that is created between clients and their auditor. This becomes the value-added.
… because even though we talk about the value added in the audit, the ultimate goal is to audit the financial statements, and that is a service that everybody can do, however it's the relationships with people at all levels that is important.
A recurring theme that emerged when participants discussed their relationship with their audit firm was the availability of the auditor. Clients want to know that their auditor is available to them. Clients not only want to feel as if they can contact their auditor without fear of an ad hoc bill arriving a day or two later, but also appreciate auditors who check in with them to see how things are going. The following three participants provide examples of the value of auditor availability:
We have a strategic plan. Our audit firm asked us to come and present it to them. I am convinced that we will not be billed for this service. When we go in two or three weeks, there will be several people from the firm around the table. We will discuss our strategy together. This is an occasion to demonstrate that they take to heart what happens in our company, because they want to be there for us … and it is not done in the spirit of offering us advice but rather to better understand our company and our business and to see how they could better service us as auditors.
… a good relationship doesn't mean we have to go for dinner every month or for lunch. No it's not that. It's just a phone call: “Hi is everything going well? How's business? Do you guys need anything?” It means we are on their agenda, that they care … it's not just “I'm coming for the audit, pay me and see you next year.”
… everybody gets newsletters and updates on accounting norms, but to have access to people at the firm to call and brainstorm ideas or technical problems … for example I pick up the phone and I say we just did this transaction and I think we can account for it this way, are there other ways to do it, do I understand it correctly?
Clients want audit firms to go beyond the core audit and provide more business advice. Clients recognize that the audit firm is part of a large network of partners and other clients from different and similar industries, located in various geographical areas. Eleven clients stated that they would like to increase their communication with the auditor and benefit from the audit firm network, with the excerpts below from two interviewees illustrating this point:
some extra business advice would be extremely important to us. And this is honestly something that is lacking … yes we have a conversation once a year, but as a customer you need those conversations more often than once a year and really like specifics. Like, “There's this research in the software business, did you know about that?” They could provide us more regarding the business.
… at the end of the year, in my year-end meeting, (the auditor) will come with some ideas but in my opinion does not go very far … we would really appreciate more.
Seven participants mentioned validation as a source of value. The audit as validation of a financial director's work also is highly valued, as evidenced by the two following quotations from clients:
you are responsible for the financial statements and they're coming in to validate what you did … that's the theory … you know we moved to IFRS … and like it or not this is not what our guys do all day … like, for example, companies are going through valuation of intangibles and goodwill because the economy's been tough … so people are doing the work, but the auditors are challenging you … it kind of puts you on guard.
As the CFO it does bring sanity and a cross check on how things are, on what's happening in different parts of the organization.
Four participants highlighted the importance of auditor independence as a valuable part of the audit service. Regulators and standard setters might be concerned that clients' desire for closer relationships with their auditors could threaten auditor independence. However, clients also stressed the importance of maintaining distance (i.e., close, but not too close). Independence was in itself an important value to clients, as exemplified by the following excerpts from two client interviews:
for the owner he has confidence in me … but I need to have total independence so when I give the owner the final financial statements he is confident that the statements reflect the reality of the company.
… and I think in the audit, this is challenging for people to understand that the auditors got to kind of draw a line. They are not your friends and they got a job … and I think that companies need to shoulder part of the responsibility.
DISCUSSION AND CONCLUSION
We interviewed 20 financial directors who participate in audit firm appointment decisions, asking in-depth questions about their past and possible future reasons for switching audit firms as well as questions regarding the perceived value of the audit service. Our interviews highlighted the importance of the auditor-client relationship and revealed how problems with the auditor-client relationship can cause the client to start paying more attention to audit pricing (i.e., both audit fees and extra billings). To the best of our knowledge this is the first study that demonstrates how the service relationship between the auditor and the client could interact with audit pricing. The audit fee still is an important factor, but evidence from our interviews shows that the relevance of fees is emphasized only when the relationship with the client is deteriorating. In addition, with respect to extra billings, it is the relational aspect of the billing (i.e., the way the auditor handles the billing) that irritates the client, not the bill itself. Our findings suggest that audit service quality as opposed to audit quality (cf. DeAngelo 1981) plays a significant role in audit firm retention decisions.
In light of the overwhelming importance of the auditor-client relationship, as is evident in the interviews with clients, our study contributes to the literature by improving our understanding of what constitutes a strong auditor-client relationship from the client's perspective. We provide evidence on the importance of availability, a previously unexplored element of value-added audit service. In light of our findings, auditors should focus on developing personal relationships with individuals at various levels within client organizations, from junior employees to managing officers. Auditors need to ensure that their clients perceive them as “available.” Auditors can enhance perceptions of availability, and establish an attentive relationship, by the simple gesture of an informal telephone call to see how things are going with the client, or being more present at the client location throughout the year, not only at a year-end meeting. This applies not only to audit partners, but also to seniors and managers.
Clients need to believe that they can trust their auditors to be there for them when needed. Trust is based on mutual commitment (Morgan and Hunt 1994; de Ruyter and Wetzels 1999) and is established by the expectations of the actions of others (Sztompka 1999). Our results indicate that one way that trust could be breached is through unexpected billings. Audit firms should communicate with their clients in advance on how the client would prefer any extra billings to be handled to avoid surprises and to preserve and enhance trust.
Our results also indicate that clients appreciate other types of value-added service, such as advice on accounting and general business issues. Audit firms increasingly should look for ways to provide their clients with feedback on issues that are important to them (e.g., tax savings, impending accounting standards, internal control improvement). This advice and feedback can be delivered formally (i.e., in the management letter) and informally. Along with the value-added aspects of the audit, clients also place importance on the core audit service and auditor independence. For example, some respondents discussed the complexity of accounting issues, such as IFRS adoption, and the importance of an outside team of experts to validate their work. Therefore, auditors should be technically proficient in dealing with new and complex accounting matters that affect their clients. Obviously, audit firms must remain independent of their clients, and personal relationships with the clients should not compromise independence, which presents a fine line.
Our study has limitations. We caution that the comments from our 20 participants might not be representative of a larger client population. Future research could conduct a survey or experiment to test the linkages conceptualized in Figure 1. Dyadic interviews between audit partners and their clients also could be carried out to determine what each party expects from the other in order to better understand how loyalty between auditors and clients is developed and how auditors can add value. More focused research involving managers with experience in changing audit firms could be conducted to better understand the factors that prompted actual switching behavior. For publicly traded companies, future work could compare and contrast the responses of company management with those of the company's audit committee members. Finally, research could be carried out specifically to investigate how the financial managers of U.S. public companies may influence audit committee decisions in the post-SOX period.
Even among U.S. public clients in the post-Sarbanes-Oxley (SOX) period, CFOs continue to influence audit firm appointment decisions (Reason 2010).
We selected this qualitative approach because of the lack of in-depth data obtained directly from audit clients. In-depth interviews, as opposed to mailed surveys, are preferable because mailings may be limited in their ability to solicit appropriate amounts of in-depth (i.e., rich) data (Beattie and Fearnley 1998; Paulin et al. 2000).
We thank an anonymous reviewer for helpful assistance with this figure.
We recognize that not everything a client desires from their auditors may be permissible in a post-SOX world (e.g., consulting services). Sometimes, auditors must walk a fine line in terms of advising clients on a transaction and subsequently auditing the transaction. However, Knechel (2007, 404) notes that audits still can be “value-added” in the post-SOX period—as long as they are not “fee-added.”
Richard Fontaine and Soumaya Ben Letaifa are both Professors at the University of Quebec at Montreal and David Herda is an Assistant Professor at North Dakota State University.
We thank Rich Houston and Dorsey Baskin (editors), Phil Cowperthwaite (partner of Cowperthwaite Mehta), and two anonymous reviewers for their helpful comments and suggestions. We are also grateful for the generous support provided by the Corporate Reporting Chair of the Accounting Department at the University of Quebec at Montreal.