- Email: [email protected]
Price setting and the value of a strong brand name
381
Price setting and the value of a strong brand name Michael
Firth *
School of Accountancy and Business, Nanyang Technological Unwersity, Nanyang Avenue, Singapore 2243
The measurement of quality for a service product is very difficult and consumers have to rely heavily on the brand name reputation of the supplier. This paper examines whether the brand name reputation of accounting firms, who supply audit services, earn premium audit fees. The sample data uses accounting firms who switched brand names and the effect of this switch on audit fees is analyzed. The results indicate that the repositioning of brand to that of a high prestige name leads to higher audit fee revenue. Brand name reputation appears to be important in the provision of audit services.
Introduction
One characteristic of services marketing is the intangible nature of the ‘product’ sold (Berry and Parasuraman, 1991). This make’s it difficult for consumers to evaluate quality prior to purchase and, in some cases, even subsequent to purchase. One way that consumers of services may infer quality is via the brand name reputation of the service provider. It has been argued that producers with strong reputations are associated with high quality and are often able to charge higher prices for their services (Aaker, 1991). The price premium for high reputation providers can occur even if service quality is
Correspondence to: M. Firth, School of Accountancy Business, Nanyang Technological University. Nanyang enue, Singapore 2263.
and Av-
* I would like to thank the referees and editor for their helpful comments on an earlier version of the paper. Intern. J. of Research North-Holland
in Marketing
10 (1993) 381-386
0167-8116/Y3/$06.00
0 1993 - Elsevier
Science
Publishers
no different from that of average or low reputation suppliers (Berry, 1988; Farquhar, 19891, although there is likely to be an erosion of reputation over time if this practice continues. It is also argued that consumers can infer quality from prices charged for products as well as from brand name (Kotler and Bloom, 1984; Zeithaml, 1988; Aaker, 1991). The purpose of the paper is to examine whether price premiums can be earned by high reputation suppliers of services. In particular, the market for audit services is analyzed and the importance of brand name is evaluated. A reputable brand name audit can be valuable for some client companies as it may reduce the perceived risk of the firm in the eyes of investors and bankers. The data set is drawn from New Zealand, where recent institutional changes in the naming of accounting firms allow some insights into the importance of brand names in determining audit fees.
Audits, brand name, and fees
Although statutory regulations and professional rules may imply a common absolute standard across all audits some recent research has postulated the existence of product segmentation in the market for audits in that there exist perceived quality differences among auditors and that consumers may demand differing levels of quality. Firth and Smith (1992) suggest that the larger firms of auditors have a substantial amount of reputational capital, which may translate into perceptions of higher quality audits in the
B.V. All rights reserved
382
M. Filth / Price seiting and the value of a strong brand name
minds of investors, and that higher audit fees are earned by these accounting firms. At the empirical level accounting researchers have typically adopted a ‘Big Eight’-‘non Big Eight’ categorization in determining large, or strong brand name, auditors. The Big Eight are the auditing firms of Arthur Andersen, Arthur Young, Coopers and Lybrand, Deloitte Haskins and Sells, Ernst and Whinney, Peat Marwick Mitchell, Price Waterhouse, and Touche Ross. Recently mergers have reduced the Big Eight to six firms. At the time of the study, however, the Big Eight were still in existence and the description ‘Big Eight’ is therefore used in this paper. This categorization has been used in previous audit pricing research although the results have been inconclusive with some studies suggesting a premium for the Big Eight brand name while others found no premium. Prior research using New Zealand data (Firth, 198.5) found no premium fees were earned by the New Zealand (N.Z.) affiliates of the Big Eight; this research was carried out on data from the period 1981-1983 when, with the exception of Price Waterhouse, auditing firms had to use their local N.Z. names. Price Waterhouse had an office in New Zealand before the New Zealand Society of Accountants imposed restrictions that the local accounting firms could not use their international affiliates’ names. In 1983 the New Zealand Society of Accountants (NZSA) revised their rules so that a local accounting firm may change its name to that of its international affiliate. Within a year all the accounting firms in New Zealand with Big Eight connections changed their names to those of their international affiliates. This institutional change in the naming of accounting firms yields a natural experiment of the impact of brand name on the level of audit fees. The change in name was not accompanied by a change in auditing technology employed by the firm and nor were there any exceptional personnel changes; for
all intents and purposes the only change related to the brand name. There is little anecdotal evidence as to why these accounting firms changed their practice names to that of their international affiliates. However, the services marketing literature argues for the development of product positioning and brand recognition (Congram and Dumensic, 1986; Gummesson, 1978) and if the international Big Eight name carries more prestige then this might provide the motivation for name changes. The Big Eight names are well known globally and the increasingly internationalized nature of New Zealand business and financial markets makes international brand names more important. Kotler and Bloom (19841 state that the overall (as opposed to local) reputation of the audit firm and worldwide coverage are important characteristics that companies consider in selecting auditors. The formal incorporation of the New Zealand firms into the international Big Eight accounting organizations may enhance their prestige and perceived quality to such an extent that they can earn premium audit fees. In order to examine whether a Big Eight brand name led to differential audit fees various other factors which influence audit fees have to be controlled. Prior research (Simunic, 1980) has suggested that the size, complexity, and risk of the individual audit client are likely to be important determinants of the audit fee. The research design isolates the impact of these other factors.
Data and methodology
The sample data come from manufacturing companies listed on the New Zealand Stock Exchange. The data were collected for the years 1981 to 1986; these dates cover the period when the NZSA changed its rules regarding the naming of accounting firms. A
M. Firth ,/ Pnke setting and the c,alue of a strong brand name
total of 600 client companies were used in the sample. The research design involved regressing audit fees against measures of the brand name of the accounting firm and client company size, complexity, risk, and profitability, with the last four factors being control variables. A pooled time-series, cross-sectional audit fee model using data for all years in the period 1981-1986 was tested. The variables used in the regression model, apart from those representing the brand name type of the accounting firms, were selected on the basis of those which were found to be significant explanators in prior audit fee research. Data for the variables were extracted from client company accounts and were scaled to 1986 price levels using the Consumer Price Index. The brand name of the accounting firm is addressed via three dummy variables. They are: NZB7: NZB7 takes the value one if the auditor is one of the seven New Zealand firms who were affiliates of seven of the Big Eight accounting firms (Price Waterhouse is the missing Big Eight firm), otherwise zero. The seven are Barr Burgess and Stewart, Hunt Duthie, Hutchison Hull, Gilfillan Morris, Lawrence Anderson and Buddle, McCulloch Menzies, Wilkinson Wilberfoss. The coefficient and its statistical significance will indicate whether these firms earn premium fees compared to their smaller sized counterparts. Previous research (Firth, 1985) indicated that these firms did not earn larger fees. PW: Price Waterhouse is the one Big Eight firm which used its own name prior to 1983. PW is coded one if the auditor was Price Waterhouse; otherwise zero. If Price Waterhouse earns a premium for its services, then
B7:
383
there should be a significant positive coefficient on the variable PW. If the auditor is one of Arthur Andersen, Arthur Young, Coopers and Lybrand, Deloitte Haskins and Sells, Ernst and Whinney, Peat Marwick Mitchell, Touche Ross, then B7 is coded one. Other auditors are coded zero. If the Big Eight name has any impact on audit fees, after controlling for client company characteristics, then a significant and positive coefficient on B7 should be observed.
In addition to the brand name characteristic of the accounting firm various clientspecific factors are likely to have an impact on the level of audit fees; these other factors have to be controlled for in the model. Clearly the size of the audit client will be a major determinant of the audit fee. The variable SIZE is measured as the square root transformation of total assets. Some assets are more complex to audit than others and this will increase the workload of the auditor (and their fee?). Examples of such complexto-audit assets are accounts receivable and inventory. The ratios accounts receivable/ total assets (AR / TA) and inventory/ total assets (ZNv/ TA) are hypothesized to have a positive relationship with the level of the audit fee. The more subsidiaries (SUBSZDS) a company has, the more time consuming is the audit. The presence of current cost accounts (CCA) is also likely to increase audit time as these inflation-adjusted financial statements need to be audited. SUBSZDS is measured by the square root of the number of subsidiaries a client company has and CC4 is a binary choice variable coded one if the client company has current cost accounts, otherwise zero; both variables are expected to be positively related to audit fees. AR/ TA, ZNV/TA, SUBSIDS, and CCA are all examples of complexity variables.
384
M. Firth / Price setting and the c.alue of a strong brand name
The higher the risk of the audit client the greater should be the audit fee; this is predicated on both the extra work the auditor might undertake so as to mitigate audit risk and a compensation for the possible increased chance of litigation against the accounting firm that frequently surrounds risky client companies. Three variables were used to proxy this risk; they are LOSS (existence of a client company loss within the last three years is coded one, otherwise zero), PROFZWAR (the variability in client’s profitability over a ten year period), and UR (the unsystematic risk component of stock market returns). The measurement of these variables leads to an expectation of a positive relationship for each of them with the level of the audit fee. PROFIT represents the client company’s return on shareholders’ equity. Arguments can be made to the effect that the higher the return the greater the client’s ability to pay audit fees. It should be noted, however, that this variable has not been found to be significant in previous research.
Results
Table 1 shows descriptive statistics for the continuous variables and the results of the pooled time-series, cross-sectional regression are shown in Table 2. The control variables of SIZE,AR/TA, CCA and UR were all Table 1 Descriptive
statistics
Variable
Mean
Standard deviation
AUDIT FEE ($ 000) SIZE ($ million) AR/TA INV/ TA SUBSIDS PROFITKAR PROFIT UR
125.72 125.81 0.24 0.30 6.53 21.34 12.70 40.26
182.96 180.37 0.12 0.14 8.04 14.21 9.03 31.65
Table 2 Regression name
of audit
fee on financial
variables
Variable
Regression coefficient
t-Value
SIZE AR/TA INV/ TA SUBSIDS CCA LOSS PROFIWAR PROFIT UR NZB 7 PW B7 Intercept R’ F-value
11.21 258.73 - 10.61 2.37 4.83 12.17 0.71 2.26 0.92 4.27 5.38 4.96 - 189.74 0.75 38.27
10.61 2.98 - 0.82 1.20 3.06 0.86 0.45 1.38 2.53 I .06 2.49 2.38 -4.39
’ An asterisk
means
significant
and
auditor
a
* *
*
* * * *
at the 0.05 level.
found to be statistically significant and had the hypothesized directional signs. The R' of 0.75indicates a high percentage of the variation in audit fees is explained by the regression model; this is consistent with other studies. As with prior research, SIZE is the major contributor to the explanatory power. The main focus of the study is on the three brand name variables PW, NZB7, and B7. The coefficient on PW is positive and statistically significant indicating an audit fee premium for Price Waterhouse. Although the coefficient on NZB7 is positive it is not statistically significant thereby indicating that the large New Zealand auditing firms practicing under their local names, but affiliated with member firms of the international Big Eight, were not earning premiums over other audit firms. B7, representing seven of the ‘Big Eight’ auditors, had a significant and positive coefficient indicating a premium earned by those firms. These were the same seven accounting firms making up NZB7 but they were now using the Big Eight firm name. The size, complexity, risk, and profitability of client companies, and the audit technology em-
M. Firfh / Price setting and the l,alue of a strong brand name
ployed by the accounting firms, could not explain the increase in audit fees when the NZB7 switched to using a Big Eight name. Instead, the results suggest that it is the brand name of an international Big Eight auditor that enables higher audit fees to be charged to client companies. On average the audit fee premium associated with a switch to a Big Eight brand name amounted to $4960. In order to examine the percentage change in audit fee attributed to the change in brand name, a prediction from the model (with B7 set equal to zero> was calculated for audit fees in 1983/1984 (the first audit that the accounting firm used the international name). The predictions (115 in total) were compared with actual audit fees and the difference (error) was expressed as a percentage of the actual. For the 25 cases that were not audited by members of the Big Eight, the average percentage error was -0.9% with 13 negative (actual less than predicted) observations and 12 positive (actual greater than predicted). For companies audited by Big Eight accountants the average percentage prediction error was 4.1% with 71 recording positive errors (actual greater than predicted) and just 6 having negative errors. One caveat to the estimate of the premium attached to a Big Eight brand name is that accounting firms may ‘phase in’ the fee premium over several years and this is difficult to estimate given other changes which impact audit pricing over time. Another outcome from the switch in brand name was the change in market share for the Big Eight. This change in market share is difficult to measure as accounting firms do not disclose the number of audit clients and their total fees. However, the market share of listed clients is observable and the Big Eight’s audits of stock exchange quoted companies rose by 10% over the period 19811986. It is acknowledged that the Big Eight’s (or their NZ predecessors) market share has been increasing since the 1970s and part of
385
the expansion has been due to taking over other, non Big Eight, accounting practices. Therefore, a precise evaluation of whether the brand name change has accelerated the growth of market share by the Big Eight is difficult.
Conclusion
The results indicate that having and using a Big Eight accounting firm brand name is associated with premium audit fees. This is consistent with a Big Eight name being perceived as a high quality producer of audits and that companies are willing to pay higher fees for their brand name services even though the nature and scope of the audit is identical to that of the previous audit carried out under the banner of the NZ name. While there is considerable competition within the Big Eight accounting firms they have a strong motivation to maintain the status of the Big Eight as a group and to prevent any expansion of the group. The increasing market share of the Big Eight together with the premium audit fees these accounting firms earn provide the incentives for maintaining and enhancing the status of the group. The Big Eight market share has shown a steady increase in the past twenty years and some of this has been accomplished by taking over medium and small size accounting practices and their client bases. One motivation for agreeing to be acquired by a Big Eight firm might be the prospect of increased fees from a given client even if the audit work is no more onerous or time consuming than before. Brand name appears to be important in the provision of audit services. One characteristic of the service is that the conduct of the audit is unobservable to investors and the outcome of the process, namely the audit report, follows a standard format with little or no variation in wording and content. The
386
M. Filth / Price setting and the calue of a strong brand name
credibility of the audit appears to rest on the one observable differentiating characteristic of the report-the name of the accounting firm. Accounting firms, and especially the Big Eight, spend considerable resources to protect and enhance their reputation and brand name. This effort appears to be rewarded with higher fee income (of the order of 4%) and the brand name itself is responsible for a large part of the fee premium.
References Aaker, D.A., 1991. Managing brand equity. New York, NY: The Free Press. Berry, N.C., 1988. Revitalizing brands. Journal of Consumer Marketing 5 (Summer), 15-20.
Berry, L.L. and A. Parasuraman, 1991. Marketing services. New York, NY: The Free Press. Congram, CA. and R.J. Dumensic, 1986. The accountant‘s strategic marketing guide. New York, NY: Wiley. Farquhar. P.H., 1989. Managing brand equity. Marketing Research 1 (Sep.), 24-33. Firth, M.A.. 1985. An analysis of audit fees and their determinants in New Zealand. Auditing: A Journal of Practice and Theory 4 (Spring). 23-37. Firth, M.A. and A.M.C. Smith, 1992. Selection of auditor firms by companies in the new issue market. Applied Economics 24 (Feb.), 247-255. Gummesson, E.. 1978. Toward a theory of professional service marketing. Industrial Marketing Management 7 (Apr.). 89-95. Kotler, P. and P.N. Bloom, 1984. Marketing professional services. Englewood Cliffs, NJ: Prentice Hall. Simunic, D., 1980. The pricing of audit services: Theory and evidence. Journal of Accounting Research 18 (Spring). 161-190. Zeithaml, V.A., 1988. Consumer perceptions of price. quality. and value: A means-end model and synthesis of evidence. Journal of Marketing 52 (July), 2-22.
Price setting and the value of a strong brand name Michael
Firth *
School of Accountancy and Business, Nanyang Technological Unwersity, Nanyang Avenue, Singapore 2243
The measurement of quality for a service product is very difficult and consumers have to rely heavily on the brand name reputation of the supplier. This paper examines whether the brand name reputation of accounting firms, who supply audit services, earn premium audit fees. The sample data uses accounting firms who switched brand names and the effect of this switch on audit fees is analyzed. The results indicate that the repositioning of brand to that of a high prestige name leads to higher audit fee revenue. Brand name reputation appears to be important in the provision of audit services.
Introduction
One characteristic of services marketing is the intangible nature of the ‘product’ sold (Berry and Parasuraman, 1991). This make’s it difficult for consumers to evaluate quality prior to purchase and, in some cases, even subsequent to purchase. One way that consumers of services may infer quality is via the brand name reputation of the service provider. It has been argued that producers with strong reputations are associated with high quality and are often able to charge higher prices for their services (Aaker, 1991). The price premium for high reputation providers can occur even if service quality is
Correspondence to: M. Firth, School of Accountancy Business, Nanyang Technological University. Nanyang enue, Singapore 2263.
and Av-
* I would like to thank the referees and editor for their helpful comments on an earlier version of the paper. Intern. J. of Research North-Holland
in Marketing
10 (1993) 381-386
0167-8116/Y3/$06.00
0 1993 - Elsevier
Science
Publishers
no different from that of average or low reputation suppliers (Berry, 1988; Farquhar, 19891, although there is likely to be an erosion of reputation over time if this practice continues. It is also argued that consumers can infer quality from prices charged for products as well as from brand name (Kotler and Bloom, 1984; Zeithaml, 1988; Aaker, 1991). The purpose of the paper is to examine whether price premiums can be earned by high reputation suppliers of services. In particular, the market for audit services is analyzed and the importance of brand name is evaluated. A reputable brand name audit can be valuable for some client companies as it may reduce the perceived risk of the firm in the eyes of investors and bankers. The data set is drawn from New Zealand, where recent institutional changes in the naming of accounting firms allow some insights into the importance of brand names in determining audit fees.
Audits, brand name, and fees
Although statutory regulations and professional rules may imply a common absolute standard across all audits some recent research has postulated the existence of product segmentation in the market for audits in that there exist perceived quality differences among auditors and that consumers may demand differing levels of quality. Firth and Smith (1992) suggest that the larger firms of auditors have a substantial amount of reputational capital, which may translate into perceptions of higher quality audits in the
B.V. All rights reserved
382
M. Filth / Price seiting and the value of a strong brand name
minds of investors, and that higher audit fees are earned by these accounting firms. At the empirical level accounting researchers have typically adopted a ‘Big Eight’-‘non Big Eight’ categorization in determining large, or strong brand name, auditors. The Big Eight are the auditing firms of Arthur Andersen, Arthur Young, Coopers and Lybrand, Deloitte Haskins and Sells, Ernst and Whinney, Peat Marwick Mitchell, Price Waterhouse, and Touche Ross. Recently mergers have reduced the Big Eight to six firms. At the time of the study, however, the Big Eight were still in existence and the description ‘Big Eight’ is therefore used in this paper. This categorization has been used in previous audit pricing research although the results have been inconclusive with some studies suggesting a premium for the Big Eight brand name while others found no premium. Prior research using New Zealand data (Firth, 198.5) found no premium fees were earned by the New Zealand (N.Z.) affiliates of the Big Eight; this research was carried out on data from the period 1981-1983 when, with the exception of Price Waterhouse, auditing firms had to use their local N.Z. names. Price Waterhouse had an office in New Zealand before the New Zealand Society of Accountants imposed restrictions that the local accounting firms could not use their international affiliates’ names. In 1983 the New Zealand Society of Accountants (NZSA) revised their rules so that a local accounting firm may change its name to that of its international affiliate. Within a year all the accounting firms in New Zealand with Big Eight connections changed their names to those of their international affiliates. This institutional change in the naming of accounting firms yields a natural experiment of the impact of brand name on the level of audit fees. The change in name was not accompanied by a change in auditing technology employed by the firm and nor were there any exceptional personnel changes; for
all intents and purposes the only change related to the brand name. There is little anecdotal evidence as to why these accounting firms changed their practice names to that of their international affiliates. However, the services marketing literature argues for the development of product positioning and brand recognition (Congram and Dumensic, 1986; Gummesson, 1978) and if the international Big Eight name carries more prestige then this might provide the motivation for name changes. The Big Eight names are well known globally and the increasingly internationalized nature of New Zealand business and financial markets makes international brand names more important. Kotler and Bloom (19841 state that the overall (as opposed to local) reputation of the audit firm and worldwide coverage are important characteristics that companies consider in selecting auditors. The formal incorporation of the New Zealand firms into the international Big Eight accounting organizations may enhance their prestige and perceived quality to such an extent that they can earn premium audit fees. In order to examine whether a Big Eight brand name led to differential audit fees various other factors which influence audit fees have to be controlled. Prior research (Simunic, 1980) has suggested that the size, complexity, and risk of the individual audit client are likely to be important determinants of the audit fee. The research design isolates the impact of these other factors.
Data and methodology
The sample data come from manufacturing companies listed on the New Zealand Stock Exchange. The data were collected for the years 1981 to 1986; these dates cover the period when the NZSA changed its rules regarding the naming of accounting firms. A
M. Firth ,/ Pnke setting and the c,alue of a strong brand name
total of 600 client companies were used in the sample. The research design involved regressing audit fees against measures of the brand name of the accounting firm and client company size, complexity, risk, and profitability, with the last four factors being control variables. A pooled time-series, cross-sectional audit fee model using data for all years in the period 1981-1986 was tested. The variables used in the regression model, apart from those representing the brand name type of the accounting firms, were selected on the basis of those which were found to be significant explanators in prior audit fee research. Data for the variables were extracted from client company accounts and were scaled to 1986 price levels using the Consumer Price Index. The brand name of the accounting firm is addressed via three dummy variables. They are: NZB7: NZB7 takes the value one if the auditor is one of the seven New Zealand firms who were affiliates of seven of the Big Eight accounting firms (Price Waterhouse is the missing Big Eight firm), otherwise zero. The seven are Barr Burgess and Stewart, Hunt Duthie, Hutchison Hull, Gilfillan Morris, Lawrence Anderson and Buddle, McCulloch Menzies, Wilkinson Wilberfoss. The coefficient and its statistical significance will indicate whether these firms earn premium fees compared to their smaller sized counterparts. Previous research (Firth, 1985) indicated that these firms did not earn larger fees. PW: Price Waterhouse is the one Big Eight firm which used its own name prior to 1983. PW is coded one if the auditor was Price Waterhouse; otherwise zero. If Price Waterhouse earns a premium for its services, then
B7:
383
there should be a significant positive coefficient on the variable PW. If the auditor is one of Arthur Andersen, Arthur Young, Coopers and Lybrand, Deloitte Haskins and Sells, Ernst and Whinney, Peat Marwick Mitchell, Touche Ross, then B7 is coded one. Other auditors are coded zero. If the Big Eight name has any impact on audit fees, after controlling for client company characteristics, then a significant and positive coefficient on B7 should be observed.
In addition to the brand name characteristic of the accounting firm various clientspecific factors are likely to have an impact on the level of audit fees; these other factors have to be controlled for in the model. Clearly the size of the audit client will be a major determinant of the audit fee. The variable SIZE is measured as the square root transformation of total assets. Some assets are more complex to audit than others and this will increase the workload of the auditor (and their fee?). Examples of such complexto-audit assets are accounts receivable and inventory. The ratios accounts receivable/ total assets (AR / TA) and inventory/ total assets (ZNv/ TA) are hypothesized to have a positive relationship with the level of the audit fee. The more subsidiaries (SUBSZDS) a company has, the more time consuming is the audit. The presence of current cost accounts (CCA) is also likely to increase audit time as these inflation-adjusted financial statements need to be audited. SUBSZDS is measured by the square root of the number of subsidiaries a client company has and CC4 is a binary choice variable coded one if the client company has current cost accounts, otherwise zero; both variables are expected to be positively related to audit fees. AR/ TA, ZNV/TA, SUBSIDS, and CCA are all examples of complexity variables.
384
M. Firth / Price setting and the c.alue of a strong brand name
The higher the risk of the audit client the greater should be the audit fee; this is predicated on both the extra work the auditor might undertake so as to mitigate audit risk and a compensation for the possible increased chance of litigation against the accounting firm that frequently surrounds risky client companies. Three variables were used to proxy this risk; they are LOSS (existence of a client company loss within the last three years is coded one, otherwise zero), PROFZWAR (the variability in client’s profitability over a ten year period), and UR (the unsystematic risk component of stock market returns). The measurement of these variables leads to an expectation of a positive relationship for each of them with the level of the audit fee. PROFIT represents the client company’s return on shareholders’ equity. Arguments can be made to the effect that the higher the return the greater the client’s ability to pay audit fees. It should be noted, however, that this variable has not been found to be significant in previous research.
Results
Table 1 shows descriptive statistics for the continuous variables and the results of the pooled time-series, cross-sectional regression are shown in Table 2. The control variables of SIZE,AR/TA, CCA and UR were all Table 1 Descriptive
statistics
Variable
Mean
Standard deviation
AUDIT FEE ($ 000) SIZE ($ million) AR/TA INV/ TA SUBSIDS PROFITKAR PROFIT UR
125.72 125.81 0.24 0.30 6.53 21.34 12.70 40.26
182.96 180.37 0.12 0.14 8.04 14.21 9.03 31.65
Table 2 Regression name
of audit
fee on financial
variables
Variable
Regression coefficient
t-Value
SIZE AR/TA INV/ TA SUBSIDS CCA LOSS PROFIWAR PROFIT UR NZB 7 PW B7 Intercept R’ F-value
11.21 258.73 - 10.61 2.37 4.83 12.17 0.71 2.26 0.92 4.27 5.38 4.96 - 189.74 0.75 38.27
10.61 2.98 - 0.82 1.20 3.06 0.86 0.45 1.38 2.53 I .06 2.49 2.38 -4.39
’ An asterisk
means
significant
and
auditor
a
* *
*
* * * *
at the 0.05 level.
found to be statistically significant and had the hypothesized directional signs. The R' of 0.75indicates a high percentage of the variation in audit fees is explained by the regression model; this is consistent with other studies. As with prior research, SIZE is the major contributor to the explanatory power. The main focus of the study is on the three brand name variables PW, NZB7, and B7. The coefficient on PW is positive and statistically significant indicating an audit fee premium for Price Waterhouse. Although the coefficient on NZB7 is positive it is not statistically significant thereby indicating that the large New Zealand auditing firms practicing under their local names, but affiliated with member firms of the international Big Eight, were not earning premiums over other audit firms. B7, representing seven of the ‘Big Eight’ auditors, had a significant and positive coefficient indicating a premium earned by those firms. These were the same seven accounting firms making up NZB7 but they were now using the Big Eight firm name. The size, complexity, risk, and profitability of client companies, and the audit technology em-
M. Firfh / Price setting and the l,alue of a strong brand name
ployed by the accounting firms, could not explain the increase in audit fees when the NZB7 switched to using a Big Eight name. Instead, the results suggest that it is the brand name of an international Big Eight auditor that enables higher audit fees to be charged to client companies. On average the audit fee premium associated with a switch to a Big Eight brand name amounted to $4960. In order to examine the percentage change in audit fee attributed to the change in brand name, a prediction from the model (with B7 set equal to zero> was calculated for audit fees in 1983/1984 (the first audit that the accounting firm used the international name). The predictions (115 in total) were compared with actual audit fees and the difference (error) was expressed as a percentage of the actual. For the 25 cases that were not audited by members of the Big Eight, the average percentage error was -0.9% with 13 negative (actual less than predicted) observations and 12 positive (actual greater than predicted). For companies audited by Big Eight accountants the average percentage prediction error was 4.1% with 71 recording positive errors (actual greater than predicted) and just 6 having negative errors. One caveat to the estimate of the premium attached to a Big Eight brand name is that accounting firms may ‘phase in’ the fee premium over several years and this is difficult to estimate given other changes which impact audit pricing over time. Another outcome from the switch in brand name was the change in market share for the Big Eight. This change in market share is difficult to measure as accounting firms do not disclose the number of audit clients and their total fees. However, the market share of listed clients is observable and the Big Eight’s audits of stock exchange quoted companies rose by 10% over the period 19811986. It is acknowledged that the Big Eight’s (or their NZ predecessors) market share has been increasing since the 1970s and part of
385
the expansion has been due to taking over other, non Big Eight, accounting practices. Therefore, a precise evaluation of whether the brand name change has accelerated the growth of market share by the Big Eight is difficult.
Conclusion
The results indicate that having and using a Big Eight accounting firm brand name is associated with premium audit fees. This is consistent with a Big Eight name being perceived as a high quality producer of audits and that companies are willing to pay higher fees for their brand name services even though the nature and scope of the audit is identical to that of the previous audit carried out under the banner of the NZ name. While there is considerable competition within the Big Eight accounting firms they have a strong motivation to maintain the status of the Big Eight as a group and to prevent any expansion of the group. The increasing market share of the Big Eight together with the premium audit fees these accounting firms earn provide the incentives for maintaining and enhancing the status of the group. The Big Eight market share has shown a steady increase in the past twenty years and some of this has been accomplished by taking over medium and small size accounting practices and their client bases. One motivation for agreeing to be acquired by a Big Eight firm might be the prospect of increased fees from a given client even if the audit work is no more onerous or time consuming than before. Brand name appears to be important in the provision of audit services. One characteristic of the service is that the conduct of the audit is unobservable to investors and the outcome of the process, namely the audit report, follows a standard format with little or no variation in wording and content. The
386
M. Filth / Price setting and the calue of a strong brand name
credibility of the audit appears to rest on the one observable differentiating characteristic of the report-the name of the accounting firm. Accounting firms, and especially the Big Eight, spend considerable resources to protect and enhance their reputation and brand name. This effort appears to be rewarded with higher fee income (of the order of 4%) and the brand name itself is responsible for a large part of the fee premium.
References Aaker, D.A., 1991. Managing brand equity. New York, NY: The Free Press. Berry, N.C., 1988. Revitalizing brands. Journal of Consumer Marketing 5 (Summer), 15-20.
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