The Large Audit Firm Fee Premium: A Case of Selectivity Bias?

Audit fee studies often find large (Big 5) audit firms earn significantly higher fees than small (non-Big 5) firms, but they treat auditor choice as exogenous. In contrast, this paper takes into account that companies are not randomly assigned to audit firms. We find the effects of auditor selection bias on audit fees are statistically and economically significant. Consistent with the predictions of analytical research, our results suggest large (small) audit firms experience advantageous (adverse) selection in attracting high (low) quality companies. Our results indicate the premium earned by large audit firms is more than twice as large when selectivity effects are taken into account (53.4% compared to 19.2%).