Fool's Gold or Value for Money? The Link between Abnormal Audit Fees, Audit Firm Type, Fair‐Value Disclosures, and Market Valuation

Abstract

We analyze whether the type of the audit firm (Big 4 and industry specialist) and the abnormal audit fees are associated with the market valuation of a bank’s fair value assets. Our results indicate that different auditor types use different strategies when auditing fair value portfolios: First, we show that the Big 4 audit firms restrict the Level 3 valuations to the most illiquid assets. Thus, the banks audited by a Big 4 have a lower proportion of Level 3 assets than the banks audited by a non-Big 4. Second, the discount on the Level 3 assets is higher for the banks audited by a Big 4 than for the banks audited by a non-Big 4. Third, the discount on the Level 3 portfolios of banks with non-Big 4 auditors is higher if the unexpected audit fees are high. Because the non-Big 4 allow the usage of the Level 3 valuations for larger portions of assets, the abnormal fees seem to reflect the auditor’s perception regarding the portfolio’s valuation risk. In contrast, for the banks audited by a Big 4, the abnormal fees are not associated with the bank’s market value. We find similar effects for industry specialist auditors.