Audit fees during initial engagement in Malaysia

Purpose - The purpose of this study is to investigate whether fees discounting exists in Malaysia and whether such a practice impairs auditor independence. Design/methodology/approach - The paper employs a panel least regression of 3,003 firm‐year observations of firms listed on Bursa Malaysia for the period between 1996 and 2006. The paper collects the audit fees, auditor's identity and other firms' characteristics data from Compustat Global, Stock Performance Guide Handbook and annual reports. The annual reports are obtained from the Bursa Malaysia's web site and Mergent Online database. The paper removes initial public offering (IPO) firms, firms involved with PriceWaterhouse and Coopers and Lybrand merger and firms forced to switch auditor during the Arthur Andersen implosion in 2002. Findings - The analysis shows that price cutting occurs on initial audit engagements even when audit fees are publicly disclosed. Further tests suggest that the auditor recovers the “sunk cost” invested during the initial engagement only during the fourth year of their audit engagement. Further, the paper finds price recovery is not significantly different from normal audit fees charged for the continuing audit engagement during the first three year period of engagement, as the audit firms will only recover the cost on the fourth year of engagement. Overall, this finding has an important implication for regulators, as it suggests that price recovery due to “lowballing” does not impair auditor independence. Research limitations/implications - Due to data unavailability, this study does not consider other unique factors that determine audit fees in Malaysia. Among them are political connections, institutional investors and ethnicity. Originality/value - This is the first study that examines audit pricing during an initial engagement in Malaysia.