New business as a bargaining factor in audit pricing: evidence from emission trading schemes

Abstract

In this study, we examine whether auditors use a new business as a bargaining chip in audit pricing. Taking the launch of China’s pilot regional emissions-trading schemes (ETSs) as a quasi-natural experiment, we find that mandatory participation in an ETS results in increased audit fees subsequent to implementation of the regulation. Adopting both empirical and textual analyses to exclude three alternative explanations (auditing effort, audit risk, and reporting risk), our results suggest that a new business is used as a bargaining chip by auditors when they negotiate audit fees with their clients. Additional empirical tests suggest that pilot companies experience an increase in audit fees after ETS implementation only when the companies have less importance to the auditors, companies' CFOs do not have experience working in an accounting firm and signing auditors are better educated. These findings demonstrate that the mandatory implementation of an ETS creates a new accounting business and alters the auditor–auditee bargaining dynamics.

Keywords:

• bargaining factor
• new business
• audit pricing
• emissions-trading scheme

JEL:

• M42
• Q56
• Q58

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Because Chinese ETS pilot schemes were implemented successively in different regions, we use the general expression for the post-ETS period rather than any particular year.

2 Examples of compliance costs include the expense of collecting, managing and reporting on energy and emissions data for all operations, including the costs associated with the internal and external auditing of CO₂ data, internal and external legal advice, contract amendments to support compliance under the legislation, and time to interpret and assess the impact of the legislation, to establish new policies and procedures and to develop the human resources necessary to support a carbon management system.

3 Indirect consequences include, but are not limited to, potential increases in the price of energy or materials, government penalties, potential for financial institutions to impose more stringent requirements and extra fees with respect to accessing debt facilitiesand the loss of competition advantages versus firms located in regions without an ETS (Graham et al. 2001; Busch and Hoffmann 2007; Sato et al. 2007; Ernst and Young, 2009; Schneider 2011).

4 If a listed firm reports a net loss for 2 consecutive years (return on equity < 0%), it is designated a special treatment firm and faces various restrictions on its trading ability and finances. If it continues to post losses for another year, it is designated a particular-transfer firm, which entails a virtual suspension of trading. Furthermore, if a particular-transfer firm does not become profitable in the following year, it is completely delisted.

Additional information

Funding

Jiaxing You gratefully acknowledges financial support from National Natural Science Foundation of China (Grant No. 71790601, Grant No. 71872157). Hongtao Shen gratefully acknowledges financial support from National Natural Science Foundation of China (Grant No. 71672075), Special Fund Project for Science and Technology Innovation Strategy of Guangdong Province (Grant No. 2019B121205004).