Auditing: A Journal of Practice & Theory American Accounting Association

Vol. 32, No. 4 DOI: 10.2308/ajpt-50533

November 2013
pp. 71–93

Auditor Choice and Audit Fees in Family

Firms: Evidence from the S&P 1500
Joanna L. Ho and Fei Kang
SUMMARY: We examine auditor choice and audit fees in family firms using data from
Standard & Poor’s (S&P) 1500 firms. We find that, compared to non-family firms, family
firms are less likely to hire top-tier auditors due to the less severe agency problems
between owners and managers. Our results also show that family firms, on average,
incur lower audit fees than non-family firms, which is driven by family firms’ lower
demand for external auditing services and auditors’ perceived lower audit risk for family
firms. Our additional analysis indicates that the tendency of family firms to hire non-top-
tier auditors and to pay lower audit fees is stronger when family owners actively monitor
their firms.

Keywords: auditor choice; audit fees; family firms; agency problems.

INTRODUCTION

A
fter the failure of Arthur Andersen and the passage of the Sarbanes-Oxley Act (SOX),
top-tier accounting firms were reduced to four and audit fees increased significantly (e.g.,
GAO 2006; Asthana et al. 2009). In turn, regulators (e.g., William McDonough, former
chairman of the Public Company Accounting Oversight Board, and Christopher Cox, former
chairman of the Securities and Exchange Commission) have expressed concern about the high
degree of concentration in the audit market and encouraged public companies to consider using
smaller accounting firms (Cox 2005; McDonough 2005). It would be useful to examine whether
different types of agency problems can explain public companies’ choice of smaller accounting
firms and the variance in audit fees paid by these companies.
This study contributes to the extant literature in auditing by investigating auditor choice and
audit fees in family firms, which have a special ownership structure and different types of agency

Joanna L. Ho is a Professor at University of California, Irvine and Fei Kang is an Assistant Professor at
California State Polytechnic University, Pomona.

The authors gratefully acknowledge the insightful comments provided by the associate editor, two anonymous reviewers,
Peng-Chia Chiu, Timothy Haight, Xuan Huang, Sarah Lyon, Morton Pincus, Xuehu Song, and Steve Wu.
Editor’s note: Accepted by Donald J. Stokes.

Submitted: August 2011

Accepted: June 2013
Published Online: June 2013

71
72 Ho and Kang

problems. Family firms are both prevalent and important in the U.S.1 Moreover, Anderson and
Reeb (2003) and Ali et al. (2007) find that the ownership structure of even large public companies
is often characterized by controlling stockholders from founding families.2 Their findings provide a
different picture of family firms in the U.S. compared to the image of a more diffused ownership
structure described by Berle and Means (1932). Trotman and Trotman (2010) point out that in spite
of the importance of family businesses worldwide and the substantial amount of empirical research
on family firms, there has been very limited research on family businesses related to auditing. Our
study responds to the call by Trotman and Trotman (2010) for research on auditing issues in
publicly listed family firms.
Following prior studies (e.g., Ali et al. 2007; Chen et al. 2008), we define family firms as those
in which members of the founding family continue to hold positions in top management, sit on the
board, or are blockholders.3 Family firms have a distinctive ownership structure, as ‘‘founding
families represent a unique class of shareholders that hold poorly diversified portfolios, are
long-term investors (multiple generations), and often control senior management positions’’
(Anderson and Reeb 2003, 1304). Therefore, family owners are in a unique position to exert
influence and to monitor their firms, resulting in less severe Type I agency problems (between
managers and shareholders)4 in family firms than non-family firms. Nevertheless, family owners
may have both the incentive and opportunity to become involved in activities that are self-beneficial
but harmful to firm value, resulting in more severe Type II agency problems (between large and
small shareholders).
The unique class of family shareholders may influence firms’ auditor choice in two competing
ways. On one hand, prior studies suggest that the demand for audit quality is driven by information
asymmetry and conflicts of interest between managers and investors (e.g., Watts and Zimmerman
1983; Healy and Palepu 2001). Compared to non-family firms, family firms have less severe Type I
agency problems, which may result in a lower demand for high-quality auditors. On the other hand,
due to the more severe Type II agency problems, family firms may have incentives to hire
high-quality auditors as a signal of credible financial reporting in exchange for better contracting
terms (e.g., lower cost of capital) (Fan and Wong 2005). Overall, different theories concerning
Type I and II agency problems provide different predictions about the effects of family ownership
on auditor choice.
Family firms’ characteristics may also affect the level of audit fees. Family owners’ active
monitoring reduces the inherent risk of material misstatements in financial reporting, resulting in
lower audit effort. Further, the direct and close monitoring of firm activities by family owners can
lower information asymmetry between owners and managers, therefore reducing the demand for a
more stringent audit process and, in turn, further decreasing audit fees. However, the more severe
Type II agency problems suggest that family firms may incur higher audit fees due to higher audit
risk and greater audit effort. Therefore, the effect of family firm characteristics on audit fees
warrants empirical investigation.

1
Prior studies suggest that approximately 80 percent of all businesses in the U.S. are family owned (Daily and
Dollinger 1992), and family businesses contribute more than 50 percent of the U.S. gross domestic product
(Francis 1993).
2
Specifically, about one-third of the S&P 500 are family-controlled companies in which the founding families, on
average, own 11 percent of the cash flow rights and 18 percent of the voting rights.
3
Members of the founding family refer to the firm founder or his/her family members (by either blood or
marriage). Top management refers to key executives, including but not limited to chief executive officer and
chief financial officer. Blockholders refer to those who own at least 5 percent of the firm’s stocks.
4
Consistent with prior literature (e.g., Villalonga and Amit 2006; Chen et al. 2007), we refer to the agency
problems arising from the separation of ownership and management as Type I agency problems, and to those
between large and small shareholders as Type II agency problems.

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 73

Using data from S&P 1500 firms for the period 2000–2008, our overall results indicate that, on
average, family firms are less likely to appoint Big N auditors5 and incur lower audit fees, and the
tendency to hire non-Big N auditors and to pay lower audit fees is more significant for firms in
which family owners are the largest shareholders. Our additional analysis shows that, compared to
family firms without dual-class shares, family firms with dual-class shares tend to mitigate their
more severe Type II agency problems by hiring Big N auditors to signal their earnings quality and
they incur higher audit fees. In addition, we find that active family control (i.e., family members as
CEOs or on the board) is associated with a lower tendency to hire top-tier accounting firms and
lower audit fees.
Our paper contributes to the extant literature in the following two ways. We use different types
of agency problems in family and non-family firms to explain their auditor choice and audit fees.
Our study not only responds to recent calls for research to examine how different forms of
ownership affect audit fees (Hay et al. 2006), but also provides additional insight into the
relationship between auditor choice and family ownership, a prevalent and important ownership
structure.
Further, studying the characteristics of family firms can help us better understand the economic
efficiency of corporate governance mechanisms (Shleifer and Vishny 1997). Prior studies have
documented how characteristics and corporate behaviors differ between family firms and
non-family firms (e.g., Anderson and Reeb 2003; Anderson et al. 2003; Wang 2006; Ali et al.
2007; Chan et al. 2010; Wu et al. 2010; Chen et al. 2011).6 Our study adds to the extant literature on
family firms by examining their auditor choice and audit fees.
The remainder of the paper is organized as follows. The second section presents a review of
prior literature and develops our hypotheses. The third section provides a discussion of the sample
and research design. The fourth section presents the empirical results, followed by additional
analysis in the fifth section. The final section summarizes concluding remarks.

PRIOR LITERATURE AND HYPOTHESES DEVELOPMENT

Family Firms and Auditor Choice

Type I Agency Problems and Auditor Choice
Prior research in accounting argues that demand for audit quality is driven by information
asymmetry and conflicts of interest between managers and investors (e.g., Watts and Zimmerman
1983; Healy and Palepu 2001). Compared to non-family firms, family firms are subject to less
severe Type I agency problems. As argued by Anderson and Reeb (2003), founding families have
historical presence in their firms and usually hold a large, undiversified equity position and control
management and director posts. They are, therefore, in a unique position to influence and monitor
their firms, which leads to lower information asymmetry and fewer conflicts of interest between
shareholders and managers. Using a sample of small private firms in Finland, Niskanen et al. (2010)
find that an increase in family ownership reduces the likelihood of hiring Big 4 auditors. However,
whether their result applies to public family firms in the U.S. is not clear due to substantial
differences in regulatory provisions between the two countries and in the markets served by private

5
Throughout this paper, Big N auditors refer to Big 5 auditors before the demise of Arthur Andersen and Big 4
auditors after that event.
6
For example, compared to non-family firms, family firms perform better (Anderson and Reeb 2003), have lower
cost of debt financing (Anderson et al. 2003), and provide better earnings quality (Wang 2006; Ali et al. 2007).
However, family firms have a higher likelihood of internal control weaknesses (Wu et al. 2010; Chen et al.
2011), and their CEOs engage in more frequent insider trading and make larger and more profitable insider trades
(Chan et al. 2010).

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74 Ho and Kang

versus public companies.7 Due to the argument set forth above, we expect that in comparison to
non-family firms, family firms have lower demand for high-quality auditors to serve a monitoring
function to alleviate Type I agency problems.8

Type II Agency Problems and Auditor Choice

Conversely, concentrated ownership and the divergence between cash flow rights and voting
rights induce agency conflicts between large and small shareholders. Tight control creates an
entrenchment problem that allows controlling owners’ self-dealings to go unchallenged internally
by the board of directors or externally by takeover markets (Claessens et al. 2002). However, this
entrenchment problem may come at a price to the controlling shareholders and their firms (e.g.,
discounted share prices when issuing additional shares of equity). Consequently, the controlling
shareholders may have incentives to hire a high-quality auditor as a signal of credible financial
reporting in exchange for better contracting terms (e.g., lower cost of capital).9 This argument is
supported by Fan and Wong (2005), who found that in eight East Asian economies, firms with
Type II agency problems are more likely to employ Big 5 auditors to mitigate the share price
discounts associated with client firms’ agency problems. While legal protection for minority
shareholders is stronger in the U.S. than in East Asia, family firms in the U.S. may still have
incentives to hire Big N auditors to signal the quality of their financial reporting and, hence, to
reduce Type II agency costs.
Overall, existing theories concerning Type I and II agency problems provide competing and
alternative predictions about the effects of family ownership on auditor choice. Therefore, family
firms’ auditor choice would depend on the difference in the severity of their Type I and II agency
problems. Prior research argues that Big N auditors provide better quality service than non-Big N
auditors because of their scale, technical expertise, and reputational incentives to uncover and
expose financial reporting irregularities (Barton 2005). The empirical evidence (DeFond and
Jiambalvo 1993) also supports this argument. Therefore, we use the choice of Big N audit firms to
proxy for demand for high-quality auditors and present the following hypothesis concerning auditor
choice:
H1: Family firms are less (more) likely to hire Big N audit firms than non-family firms if
the effect of Type I (II) agency problems dominates that of Type II (I) agency
problems.

7
As argued by Ball and Shivakumar (2005), private firms are less likely to use public financial statements in
contracting with other parties, and their financial reporting is more likely to be influenced by taxation, dividend,
and other policies. Therefore, compared to public firms, private firms have a lower demand for financial
reporting quality.
8
Although the audit committee appoints auditors and determines their remuneration, founding families may
exercise their influence in selecting board members and appointing members of the audit committee. In this
regard, founding families may indirectly affect auditor selection and audit fees.
9
External auditors mainly assure minority shareholders and external parties that the company’s financial reporting
fairly reflects managers’ operation and investment decisions; external auditors have no responsibility to enhance
firm value. On the other hand, internal corporate governance mechanisms, such as external directors, play an
important role in monitoring managers’ daily operation and investment decisions. These external and internal
monitoring mechanisms may substitute each other. As family firms have more severe Type II agency problems, it
is important for them to resort to external instead of internal monitoring mechanisms to assure minority
shareholders and external parties of the firm’s financial reporting quality.

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 75

Family Firms and Audit Fees

Type I Agency Problems and Auditor Fees
Prior studies have examined the relationship between firm characteristics and audit fees, using
both supply-side and demand-side theories. From the supply-side perspective, Simunic (1980)
argues that firm characteristics affect the extent of audit work and, in turn, the level of audit fees. In
particular, prior studies have documented that assessed client risks are associated with engagement
efforts and, hence, audit fees. For example, Bell et al. (2001) reports that audit fees are raised when
an engagement partner’s assessment of business risk increases. Bedard and Johnstone (2004) find
that auditors increase engagement efforts and billing rates when clients’ corporate governance is
weak and when there is a relatively high earnings manipulation risk. As discussed above, compared
to other investors,10 family owners have stronger incentives to closely monitor managers, which
may result in lower risk of material misstatements in financial reporting and, therefore, lower audit
effort.
At the same time, demand-side theories suggest that the close and usually direct monitoring of
firm activities by family owners can lower information asymmetry between owners and managers
(Ali et al. 2007; Chen et al. 2008), resulting in lower demand for external auditing services. Based
on demand-side theories and empirical evidence, we expect that the existence of a potential
alternative monitoring mechanism may further reduce the demand for external auditing services by
family firms and, therefore, lower audit effort.
Taken together, both supply-side and demand-side theories lead us to predict that, in
comparison to non-family firms, family firms are associated with lower audit effort, and therefore
lower audit fees, because of their less severe Type I agency problems.

Type II Agency Problems and Auditor Fees

Due to the Type II agency problems embedded in their firms, family owners may have strong
incentives to engage in self-beneficial activities, such as related-party transactions. This will, in
turn, increase the assessed risk of fraudulent reporting by auditors. This argument is consistent with
a recent Committee of Sponsoring Organizations of the Treadway Commission (COSO 2010)
report that examines instances of fraudulent reporting during the period 1998–2007 and identifies
related-party transactions as a potential risk factor for fraud. When client firms have more severe
Type II agency problems, auditors are required to perform more procedures to reduce audit risk to
an acceptable level. Therefore, the entrenchment problems within family firms may result in higher
audit fees.
In summary, compared to non-family firms, family firms have less severe Type I agency
problems and therefore lower audit fees, due to less audit effort required and lower demand
for audit quality. However, the more severe Type II agency problems in family firms lead to
the prediction that they incur higher audit fees than non-family firms, due to higher audit risk
and greater audit effort. Therefore, we present the following hypothesis concerning audit
fees:
H2: Family firms incur lower (higher) audit fees than non-family firms if the effect of Type I
(II) agency problems dominates that of Type II (I) agency problems.

10
Some prior studies have documented the disinterest of some large (especially institutional) shareholders in their
companies’ performance, e.g., Bushee (1998).

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76 Ho and Kang

RESEARCH METHODOLOGY

Model Specification
As suggested by Chaney et al. (2004), client firms are not randomly assigned to auditors, and it
is likely that firms self-select audit firms based on firm characteristics, private information, or other
unobservable characteristics. Therefore, we adopt the Heckman procedure (Heckman 1979, 2001)
to allow simultaneity in firms’ auditor choice and audit fees, and also to address potential bias in the
standard ordinary least squares (OLS) regressions due to self-selection.11 In addition, the Heckman
procedure allows the coefficients in the fee equations to vary across auditor types.
Following prior research (e.g., Chaney et al. 2004; Abbott et al. 2003), we test our hypotheses
on family firms’ auditor choice and audit fees using the following regressions (all of the variable
definitions are summarized in Appendix A):
Auditor choice:

BIGNit ¼ a0 þ a1 LTAit þ a2 CHTAit þ a3 ATURNit þ a4 DAit þ a5 CURRit þ a6 QUICKit

þ a7 ROAit þ a8 LOSSit þ a9 ROAit LOSSit þ a10 SUBit þ a11 FORGNit þ a12 BIit
þ a13 CEOCHRit þ a14 ACEXPit þ a15 ACMTit þ a16 ACSIZEit þ a17 ACOUTit
þ a18 INSTit þ a19 CEOHOLDit þ a20 DIRit þ a21 FAMit þ ui þ dt þ eit :
ð1Þ
Audit fees:

LAFEEit ¼ b0 þ b1 LTAit þ b2 ATURNit þ b3 DAit þ b4 CURRit þ b5 QUICKit þ b6 ROAit

þ a7 LOSSit þ b8 ROAit LOSSit þ b9 SUBit þ b10 FORGNit þ b11 OPINit
þ b12 NAFEEit þ b13 TENUREit þ b14 BUSYit þ b15 BIit þ b16 CEOCHRit
þ b17 ACEXPit þ b18 ACMTit þ b19 ACSIZEit þ b20 ACOUTit þ b21 INSTit
þ b22 CEOHOLDit þ b23 DIRit þ b24 FAMit þ b25 IMRit þ ui þ dt þ eit : ð2Þ

We estimate Equation (1) by probit regression to test H1 on family firms’ auditor choice
(BIGN). To test H2 on audit fees (LAFEE), we first calculate the inverse Mills ratios (IMR) based
on the coefficient estimates from the probit regression of Equation (1). To allow the slope
coefficients to vary across Big N and non-Big N clients, we then estimate Equation (2) for the two
groups separately by OLS with IMR included as an additional explanatory variable. As argued by
Lennox et al. (2012), it is inadvisable to estimate selection models without exclusion restrictions, so
we include the change in the absolute value of total assets (CHTA) as the exogenous variable in the
auditor choice model as suggested by Clatworthy et al. (2009).12

11
In addition, we follow Lennox et al.’s (2012) four practical suggestions to examine the robustness of our results.
First, it is inadvisable to estimate selection models without exclusion restrictions, so we include the change in the
absolute value of total assets (CHTA) as the exogenous variable in the first stage regression as discussed later.
Second, we report independent variables that are used in the first stage models. Third, we provide a theoretical
argument to support our choice of CHTA as the exogenous variable in the models in footnote 12. Fourth, because
the selection models are often fragile, it is essential to report sensitivity analyses in order to establish the
robustness of inferences. Therefore, we perform robustness checks by the regular OLS regressions for the audit
fee model and observe qualitatively similar results. The results are available upon request.
12
Similar to Clatworthy et al. (2009), we find that CHTA is statistically significant in the auditor choice model but
insignificant in the audit fee model. As argued by Clatworthy et al. (2009), the motivation for including CHTA in
the auditor choice model is that companies involved in large investments/acquisition or divestments/sale of
assets may require the expertise of an auditor due to the additional complexity of the audit. In addition, Keasey
and Watson (1991) note that the absolute change in firm size may, from an agency perspective, act as a proxy for
contractual changes at the firm level, which could prompt a change in the demand for auditing services.

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 77

Test Variables

To test our hypotheses, we include in both regressions a dummy variable FAM, which equals 1
if the firm is classified as a family firm. Moreover, to shed light on the impacts of Type II agency
problems on family firms’ auditor choice and audit fees, we conduct our analysis by classifying
family firms on the basis of whether they have dual-class shares (Claessens et al. 2000; Villalonga
and Amit 2006). The excess control and the divergence between voting rights and cash flow rights
by founding families give them incentives to seek private benefits at the expense of other
shareholders. Villalonga and Amit (2006) find that Tobin’s Q of family firms with control-
enhancing mechanisms is significantly lower than that of family firms without such mechanisms. In
light of the prior research, we perform our analysis by replacing the family firm indicator (FAM)
with two classification variables for family firms with dual-class shares (FAM_DUAL) and those
without (FAM_NDUAL).
Finally, as shown by the descriptive statistics of family firms (Table 2), there is considerable
variation in the level of family involvement in firm management across family firms, which may
affect firms’ agency problems and demand for high-quality audits. Therefore, we examine the
impact of different attributes of family firms on their auditor choice and audit fees by replacing the
family firm indicator (FAM) with the following family firm characteristics: CEO type (founding
family members who serve as CEOs [F_CEO] versus hired-hand CEO [H_CEO]), percentage of
family member directors on the board (FAM_DIR), percentage of common stock owned by
founding family members (FAM_OWN), and percentage of excess voting rights over cash flow
rights held by founding family members (FAM_VC).

Control Variables
Following prior studies on auditor choice and audit fees, we expect that client firm size,
complexity, and risk affect auditor choice and audit fees (Carcello et al. 2002; Ashbaugh et al. 2003).
We proxy firm size by the natural logarithm of total assets (LTA) and control for firm complexity by
assets turnover ratio (ATURN), current assets (CURR), square root of the number of subsidiaries
(SUB), and percentage of foreign sales (FORGN). To control for firm risk, we include long-term debts
ratio (DA), quick ratio (QUICK), return on assets (ROA), and loss (LOSS) in the regressions. We also
control for firms’ corporate governance characteristics and ownership structure, including board
independence (BI), CEO dual chair (CEOCHR), audit committee characteristics (financial expertise
ACEXP,13 meeting frequency ACMT, size ACSIZE, and independence ACOUT), institutional
ownership (INST), CEO ownership (CEOHOLD), and outside director ownership (DIR). In the audit
fee model, we control for factors that may affect audit-client relationship, including auditor tenure
(TENURE), the ratio of non-audit fees paid to the auditor (NAFEE),14 and the presence of modified
audit opinion (OPIN). In addition, industry- and year-specific fixed effects (ui and dt) are included in
both models to control for variation across industries or over time.

Sample Selection
The empirical analysis is performed on firms listed on the S&P 1500 index from 200015
through 2008. As discussed earlier, we define family firms as those in which founders or their

13
Following the SEC’s definition, we define financial expert broadly to include non-accounting financial experts.
14
Non-audit fee ratio measures the importance of consulting services relative to the total services provided by the
external auditor, and therefore it is an important proxy for audit-client relationship (Ghosh et al. 2009). The
results remain qualitatively similar if NAFEE is replaced with the natural log of non-audit fees in the models.
15
Year 2000 is the initial disclosure year for audit fee data mandated by the SEC.

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78 Ho and Kang

family members (by either blood or marriage) are key executives, directors, or blockholders (Ali et
al. 2007; Chen et al. 2008)16 and update the classification every year. Specifically, we first identify
key executives and directors for each firm year from ExecuComp and RiskMetrics databases. Next,
for each firm year, we read the proxy statement and corporate history (from Hoover’s database and/
or the firm’s website) to identify the founder and his/her family members and check whether the
founder or the family members are key executives, directors, or blockholders. If so, we collect the
ownership of the founding family. In addition, if the firm has created control-enhancing
mechanisms such as multiple share classes with differential voting rights, pyramids, or voting
agreements, we calculate the percentage ofxcess voting rights over cash flow rights held by the
founding family. Then, we obtain audit fees and auditor information from AuditAnalytics, firms’
financial information from Compustat, corporate governance characteristics from RiskMetrics, and
proxy statements and institutional ownership from CDA Spectrum. Finally, we merge all of the
above data, and exclude firms in regulated utilities and financial institutions (two-digit SIC codes
40–44, 46, 48–49, and 60–69) due to the unique aspects of their regulatory environments (Abbott
and Parker 2000). As a result, our final sample includes 9,219 firm-year observations from 1,100
unique firms.

EMPIRICAL RESULTS

Descriptive Statistics
Table 1 presents the sample distribution by year (Panel A) and by industry (Panel B). As
shown in Panel A, the number of firm-year observations in 2000, the initial disclosure year for audit
fee data mandated by the SEC, is lower than those in other sample years, as some data on firms’
auditor choice and audit fees in this first year are missing from AuditAnalytics. We also observe
that the percentage of family-firm observations slightly decreases from 2001 to 2005, and has
dropped below 38.0 percent since 2006.17 This declining trend is consistent with Wang’s (2006)
finding of family firms in the S&P 500. Additionally, the overall proportion of family firm-years in
the S&P 1500 in our sample (38.4 percent) is lower than that (46.3 percent) of Chen et al. (2008),
which may be attributed to the fact that our study employed a different sample period (2000–2008)
from Chen et al.’s (1996–2000). Panel B of Table 1 shows that family firms operate in a broad array
of industries, implying the importance of controlling for industry effects in our models.
Table 2 presents the descriptive statistics for the variables for the full sample and subsamples of
family and non-family firms. As shown in the table, 93.7 percent of the family firms choose Big N
auditors (BIGN), with an average audit fee (AFEE) of $1.8 million, while 96.1 percent of the non-
family firms hire Big N auditors, with an average audit fee of $3.1 million. The differences in
auditor choice and audit fees between family and non-family firms are statistically significant.
Table 2 also shows that, compared to non-family firms, family firms tend to be smaller in terms
of total assets (TA) and to have higher assets turnover ratios (ATURN), higher current ratios
(CURR), and higher quick ratios (QUICK). Conversely, family firms have lower leverage ratios

16
As argued by Ali et al. (2007), using this definition does not exclude firms with limited influence of founding
family and has the following three benefits. First, it is free of any subjective assessment of family influence, thus
making the results more reliable. Second, to the extent a firm classified as a family firm has only weak family
influence, it would introduce a conservative bias in the results. Finally, this definition of a family firm has been
widely used by recent academic studies on family firms in the U.S., thus making it easier to compare our results
with prior studies.
17
To test the robustness of our results, we perform analysis for a sample consisting of observations from 2006 to
2008, and find the results qualitatively similar to the main results.

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 79

TABLE 1
Sample Distribution
Panel A: Distribution by Year
Number of Number of Percent of
Year Firm-Years Percent Family Firm-Years Family Firm-Years
2000 618 6.7% 259 41.9%
2001 1,005 10.9% 429 42.7%
2002 1,098 11.9% 460 41.9%
2003 1,061 11.5% 429 40.4%
2004 1,084 11.8% 427 39.4%
2005 1,100 11.9% 428 38.9%
2006 1,084 11.8% 398 36.7%
2007 1,094 11.8% 360 32.9%
2008 1,075 11.7% 349 32.5%
Total 9,219 100.0% 3,539 38.4%

Panel B: Distribution by Two-Digit SIC Code

Number of Percent of
Number of Family Family
Industry Firm-Years Percent Firm-Years Firm-Years
13: Oil and gas extraction 404 4.4% 156 38.6%
15: General building contractors 113 1.2% 83 73.5%
20: Food and kindred products 345 3.7% 137 39.7%
23: Apparel and other textile products 124 1.3% 60 48.4%
27: Printing and publishing 139 1.5% 54 38.8%
28: Chemicals and allied products 792 8.6% 234 29.5%
33: Primary metal industries 176 1.9% 57 32.4%
34: Fabricated metal products 185 2.0% 70 37.8%
35: Industrial machinery and equipment 754 8.2% 251 33.3%
36: Electrical and electronic equipment 895 9.7% 377 42.1%
37: Transportation equipment 304 3.3% 107 35.2%
38: Instruments and related products 728 7.9% 265 36.4%
39: Miscellaneous manufacturing industries 114 1.2% 64 56.1%
50: Wholesale: durable goods 262 2.8% 133 50.8%
55: Auto dealers and gas stations 100 1.1% 75 75.0%
56: Apparel and accessory stores 231 2.5% 83 35.9%
58: Eating and drinking places 208 2.3% 81 38.9%
59: Miscellaneous retail 229 2.5% 93 40.6%
73: Business services 1,075 11.7% 436 40.6%
80: Health services 224 2.4% 105 46.9%
87: Engineering and management services 169 1.8% 68 40.2%
Othera 1,648 17.9% 550 33.4%
Total 9,219 100.0% 3,539 38.4%
a
Other includes those industries that have less than 100 firm-year observations or less than 50 family firm-year
observations.

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80 Ho and Kang

TABLE 2
Descriptive Statistics
Full Sample Family Firms Non-Family Firms
(n ¼ 9,219) (n ¼ 3,539) (n ¼ 5,680)
Differences
Mean Std. Dev. Mean Std. Dev. Mean Std. Dev. in Mean
Auditor Choice and Audit Fees
BIGN 0.952 0.214 0.937 0.243 0.961 0.193 0.024***
AFEE 2,613.015 4,934.142 1,835.814 3,112.225 3,097.260 5,733.420 1,261.45***
Financial Characteristics
TA 6,037.351 26,250.713 4,365.832 16,731.982 7,078.811 30,680.423 2,712.979***
CHTA 762.196 4,119.540 551.043 1,955.400 893.759 5,011.900 342.716***
ATURN 1.232 0.876 1.274 0.911 1.206 0.853 0.068***
DA 0.171 0.165 0.158 0.173 0.179 0.160 0.021***
CURR 0.459 0.218 0.478 0.232 0.447 0.208 0.031***
QUICK 1.947 2.439 2.136 2.649 1.830 2.290 0.306***
ROA 0.060 0.196 0.058 0.258 0.061 0.145 0.002
LOSS 0.152 0.359 0.149 0.357 0.154 0.361 0.004
SUB 3.889 2.176 3.374 1.931 4.211 2.316 0.837***
FORGN 0.240 0.333 0.210 0.248 0.259 0.375 0.050***
OPIN 0.209 0.406 0.208 0.406 0.209 0.407 0.001
NAFEE 0.294 0.227 0.307 0.232 0.286 0.224 0.021***
TENURE 13.488 19.401 12.135 16.677 14.332 20.876 2.197***
BUSY 0.760 0.427 0.709 0.454 0.792 0.406 0.082***
Corporate Governance Characteristics
BI 0.551 0.301 0.539 0.276 0.559 0.316 0.020***
CEOCHR 0.551 0.497 0.542 0.498 0.557 0.497 0.015
ACEXP 0.973 0.162 0.965 0.184 0.978 0.147 0.013***
ACMT 7.227 3.838 7.148 3.951 7.277 3.765 0.129
ACSIZE 3.618 1.025 3.457 0.933 3.718 1.078 0.261***
ACOUT 0.943 0.142 0.931 0.152 0.951 0.135 0.020***
INST 0.717 0.278 0.691 0.261 0.733 0.287 0.042***
CEOHOLD 0.018 0.056 0.033 0.074 0.009 0.037 0.024***
DIR 0.034 0.083 0.045 0.090 0.027 0.078 0.018***
FAM_DUAL 0.115 0.319
F_CEO 0.333 0.471
FAM_DIR 0.170 0.148
FAM_OWN 0.130 0.177
FAM_VC 0.215 0.223

*** Denotes significance at the 0.01 level.

Statistical test for differences in mean is based on a two-tailed t-test.
See Appendix A for variable definitions.

(DA), smaller numbers of subsidiaries (SUB), and smaller percentages of foreign sales (FORGN). In
addition, family firms tend to pay a higher ratio of non-audit fees and have shorter auditor tenure.
As for board characteristics, family firms tend to have lower board independence (BI), lower
audit committee independence (ACOUT), less financial expertise on the audit committee (ACEXP),
and fewer audit committee members (ACSIZE). Additionally, family firms on average have fewer

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 81

institutional holdings (INST), but more CEO holdings (CEOHOLD) and higher outside director
ownership (DIR). Our results show 11.5 percent of the family firms have dual-class shares
(FAM_DUAL), that on average founding family members own 13.0 percent of cash flow rights
(FAM_OWN), and the gap between voting rights and cash flow rights (FAM_VC) is 21.5 percent.
About one-third of the family firms (33.3 percent) are run by family-member CEOs (F_CEO).18 On
average, 17.0 percent of the board directors (F_DIR) are family members.
Table 3 presents the Pearson correlation matrix of the main variables. Auditor choice (BIGN)
and audit fees (LAFEE) are significantly and negatively correlated with FAM, the indicator for
family firm. Other significant correlations between auditor choice, audit fees, and firm
characteristics (e.g., firm size) are consistent with those reported in prior studies. We also present
the pairwise correlations between IMR and other variables in Panels C and D.

Regression Results for Auditor Choice

Our regression results for testing H1 are presented in Table 4.19 Three models are presented,
each with different measures to capture family ownership: an indicator variable (FAM),
classification variables for family firms with and without dual-class shares (FAM_DUAL and
FAM_NDUAL), and family firms’ attributes (F_CEO, H_CEO, FAM_DIR, FAM_OWN, and
FAM_VC). All models are significant at p , 0.001.20 In Model 1, we find a significant and negative
coefficient on FAM (0.116, p ¼ 0.043), indicating that, compared to non-family firms, family firms
are less likely to hire Big N auditors.21 This result shows that the effect of Type I agency problems
dominates that of Type II agency problems on family firms’ auditor choice, resulting in lower
demand for high-quality auditors by family firms compared to non-family firms.
Consistent with the results in Model 1, the coefficients for FAM_NDUAL and FAM_DUAL are
both significant and negative in Model 2. Moreover, the coefficient of FAM_NDUAL is significantly
smaller than that of FAM_DUAL,22 which suggests that family firms with dual-class shares tend to
have more severe Type II agency problems than do family firms without such mechanisms and,
therefore, have stronger need to hire Big N auditors to signal firms’ earnings quality.
The results in Model 3 show that family firm attributes have different impacts on their auditor
choice. Specifically, the coefficients on F_CEO and FAM_DIR are significantly negative, suggesting
that family members’ active involvement in management and their board representation further reduce
Type I agency problems in the firms, resulting in lower demand for high-quality auditors. Further, we
find that the coefficient for FAM_OWN is significant and negative,23 but the coefficient for FAM_VC

18
Our additional analysis shows that 66.0 percent (778/1,179) of the firms with family CEOs (F_CEO) also have
their CEOs serve as chairman of the board (CEOCHR). In other words, 15.3 percent (778/5,081) of the
CEOCHRs are also F_CEOs.
19
Throughout this paper, the p-values on the independent variables are two-tailed and based on standard errors
clustered by firm (Petersen 2009). As in our sample, the family ownership is likely to be correlated across years;
we calculate one-way (by firm) cluster-robust standard errors to correct for the time-series dependence.
20
We also perform diagnostic tests for multicollinearity and find that the variance inflation factor (VIF) scores on all the
variables in our models range from 1.052 to 9.238, which are below the standard cutoff of 10 (Kennedy 1998).
21
Wang (2006) and Ali et al. (2007) find that family firms have better earnings quality. In addition, prior literature
documents that Big N auditors are associated with better audit quality. However, our results show that family
firms are less likely to hire Big N auditors, which appears to be contradictory to the prior findings on the positive
association between earnings quality and family firms. To explain the seeming inconsistency between our results
and prior findings, we examine the relationship between family ownership, auditor choice, and earnings quality
and find that family firms have similar earnings quality regardless of auditor type.
22
The p-value for the pairwise test is less than 0.001.
23
We also examine the potential nonlinear relationship between family ownership and auditor choice by including
the square of family ownership (FAM_OWN2) in the model. Our analysis shows an insignificant coefficient of
FAM_OWN2, which is not supportive of a nonlinear relationship between family ownership and auditor choice.

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 82
TABLE 3
Pearson Correlation Matrix

Panel A: Correlations among Main Variables

FAM BIGN LAFEE LTA CHTA ATURN DA CURR QUICK ROA LOSS SUB FORGN
BIGN 0.05
LAFEE 0.17 0.11
LTA 0.10 0.19 0.76
CHTA 0.04 0.04 0.26 0.34
ATURN 0.04 0.01 0.10 0.10 0.06
DA 0.06 0.09 0.14 0.24 0.04 0.15
CURR 0.07 0.12 0.20 0.39 0.14 0.27 0.41
QUICK 0.06 0.11 0.26 0.28 0.06 0.22 0.18 0.39
ROA 0.01 0.03 0.00 0.01 0.05 0.13 0.09 0.04 0.02
LOSS 0.01 0.00 0.04 0.12 0.02 0.15 0.10 0.06 0.09 0.42
SUB 0.05 0.04 0.27 0.24 0.10 0.07 0.07 0.13 0.12 0.02 0.04
FORGN 0.07 0.04 0.27 0.15 0.04 0.17 0.06 0.11 0.05 0.02 0.03 0.07
OPIN 0.07 0.05 0.28 0.20 0.07 0.05 0.06 0.10 0.08 0.01 0.02 0.07 0.05
NAFEE 0.04 0.12 0.27 0.05 0.05 0.02 0.04 0.01 0.01 0.05 0.03 0.04 0.01
TENURE 0.06 0.09 0.32 0.33 0.15 0.03 0.05 0.09 0.11 0.02 0.05 0.13 0.09
BUSY 0.09 0.05 0.04 0.03 0.02 0.01 0.06 0.07 0.01 0.02 0.04 0.04 0.04
BI 0.03 0.05 0.42 0.42 0.08 0.04 0.08 0.13 0.10 0.02 0.03 0.13 0.14
CEOCHR 0.02 0.03 0.16 0.26 0.04 0.03 0.08 0.11 0.05 0.01 0.04 0.11 0.06
ACEXP 0.04 0.04 0.07 0.03 0.01 0.03 0.00 0.03 0.01 0.02 0.01 0.01 0.01
ACMT 0.02 0.01 0.35 0.19 0.05 0.00 0.02 0.00 0.04 0.01 0.00 0.05 0.07
ACSIZE 0.04 0.07 0.33 0.39 0.06 0.02 0.08 0.14 0.10 0.00 0.05 0.16 0.10
ACOUT 0.00 0.03 0.26 0.28 0.02 0.04 0.03 0.07 0.03 0.01 0.02 0.09 0.10
INST 0.07 0.03 0.21 0.11 0.06 0.01 0.04 0.00 0.03 0.06 0.09 0.01 0.05
CEOHOLD 0.21 0.12 0.10 0.10 0.03 0.06 0.06 0.06 0.04 0.02 0.01 0.05 0.06
DIR 0.10 0.07 0.02 0.01 0.03 0.03 0.01 0.02 0.03 0.02 0.01 0.03 0.04

(continued on next page)

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Ho and Kang
 TABLE 3 (continued)

Panel B: Correlations among Main Variables, Continued from Panel A

OPIN NAFEE TENURE BUSY BI CEOCHR ACEXP ACMT ACSIZE ACOUT INST CEOHOLD
NAFEE 0.16

November 2013
TENURE 0.07 0.00
BUSY 0.05 0.02 0.02
BI 0.18 0.13 0.25 0.03
CEOCHR 0.02 0.10 0.14 0.01 0.36
ACEXP 0.06 0.07 0.05 0.04 0.03 0.03
ACMT 0.17 0.28 0.02 0.02 0.18 0.01 0.06
ACSIZE 0.05 0.01 0.23 0.02 0.62 0.49 0.01 0.10
ACOUT 0.05 0.07 0.16 0.05 0.63 0.48 0.00 0.14 0.83

Auditing: A Journal of Practice & Theory

INST 0.12 0.25 0.03 0.03 0.32 0.15 0.07 0.21 0.22 0.28
CEOHOLD 0.05 0.00 0.05 0.02 0.03 0.08 0.07 0.03 0.00 0.04 0.11
DIR 0.05 0.10 0.01 0.02 0.21 0.03 0.01 0.03 0.11 0.15 0.00 0.19

Panel C: Pairwise Correlations of IMR with Other Variables in the Audit Fee Model 1a
LAFEE LTA ATURN DA CURR QUICK ROA LOSS SUB FORGN OPIN NAFEE
IMR 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.03 0.05

Panel D: Pairwise Correlations of IMR with Other Variables in the Audit Fee Model 1, continued from Panel C
TENURE BUSY BI CEOCHR ACEXP ACMT ACSIZE ACOUT INST CEOHOLD DIR FAM
IMR 0.05 0.05 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500

Coefficients in bold are significant at the 0.10 level.

See Appendix A for variable definitions.
a
Under the Heckman procedure, different regression models yield different IMRs. Due to the space limitation, we only report the correlations of IMR with other variables in the
Audit Fee Model 1. The correlations among IMR and controlling variables in other models are available upon request.
83
84 Ho and Kang

TABLE 4
Family Firms and Auditor Choice
Dependent Variable: BIGN
Model 1 Model 2 Model 3
Independent Variable Coeff. p-value Coeff. p-value Coeff. p-value
Intercept 1.276 1.000 1.291 1.000 1.312 1.000
FAM 0.116 0.043
FAM_NDUAL 0.119 0.041
FAM_DUAL 0.091 0.083
F_CEO 0.044 0.000
H_CEO 0.089 0.352
FAM_DIR 0.520 0.043
FAM_OWN 0.271 0.078
FAM_VC 0.357 0.069
LTA 0.344 0.000 0.345 0.000 0.333 0.000
CHTA 0.001 0.050 0.001 0.049 0.001 0.022
ATURN 0.004 0.913 0.004 0.911 0.003 0.955
DA 0.143 0.433 0.154 0.417 0.201 0.301
CURR 0.003 0.973 0.002 0.993 0.009 0.957
QUICK 0.023 0.009 0.023 0.008 0.025 0.006
ROA 0.082 0.620 0.101 0.607 0.009 0.696
LOSS 0.069 0.486 0.057 0.539 0.071 0.386
ROA  LOSS 1.107 0.062 1.212 0.021 1.234 0.027
SUB 0.020 0.281 0.020 0.273 0.029 0.200
FORGN 0.551 0.000 0.553 0.000 0.597 0.000
BI 0.214 0.152 0.219 0.148 0.207 0.168
CEOCHR 0.132 0.043 0.126 0.038 0.143 0.029
ACEXP 0.579 0.000 0.588 0.000 0.592 0.000
ACMT 0.003 0.050 0.004 0.050 0.005 0.049
ACSIZE 0.095 0.010 0.096 0.009 0.101 0.006
ACOUT 0.162 0.659 0.118 0.620 0.102 0.579
INST 0.201 0.084 0.197 0.091 0.227 0.051
CEOHOLD 0.020 0.000 0.020 0.000 0.026 0.000
DIR 0.597 0.054 0.594 0.053 0.648 0.038
Pseudo R2 0.289 0.292 0.320
Year Fixed Effects Controlled
Industry Fixed Effects Controlled
Observations 9,219
The p-values are two-tailed and based on standard errors clustered by firm.
See Appendix A for variable definitions.

is significant and positive. These results indicate that less severe Type I agency problems (proxied by
FAM_OWN) reduce family firms’ demand for high-quality auditors, while more severe Type II
agency problems (proxied by FAM_VC) increase their demand to hire Big N auditors to signal
credible financial reporting, consistent with findings in Fan and Wong (2005).
In regard to the control variables, our results are generally consistent with findings of prior
research (e.g., Ashbaugh et al. 2003; Chaney et al. 2004). The coefficients on LTA, CHTA, and
FORGN are significantly positive, suggesting that larger and complex firms are more likely to appoint

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 85

Big N auditors. We also find a significant and negative coefficient for CEOCHR, suggesting that firms
with the same person who holds both CEO and chairman of the board positions are less likely to hire
Big N auditors. Similar to Abbott and Parker (2000), we find that firms with active audit committees
(ACMT) have higher demand for high-quality auditors. In addition, the coefficients on ACEXP and
ACSIZE are significantly positive, implying the higher demand for high-quality audit services by
larger audit committees and audit committees with more financial expertise.

Regression Results for Audit Fees

Table 5 contains the results of audit fee regression, which is estimated separately for Big N
(Panel A) and non-Big N (Panel B) samples. As shown in Model 1, the coefficients on FAM
(0.135, p ¼ 0.000 for the Big N sample, 0.119, p ¼ 0.007 for the non-Big N sample) are
significantly negative,24 which suggests that, for firms choosing Big N (non-Big N) auditors, the
average audit fee of family firms is 14.5 percent (12.6 percent) lower than that of non-family firms.
As argued above, this result is driven by auditors’ perceived lower audit risk for family firms and
family firms’ lower demand for external audit services.
Consistent with the results in Model 1, the coefficients on FAM_NDUAL and FAM_DUAL are
significant and negative for both Big N and non-Big samples in Model 2. However, the coefficients
of FAM_NDUAL are significantly lower than those of FAM_DUAL, 25 suggesting that family firms
without dual-class shares tend to have less severe Type II agency problems than do family firms
with such mechanisms, therefore reducing the assessed audit risk and audit fees.
The results in Model 3 show that family firm attributes also have different impacts on their
auditor fees. Specifically, the coefficients on F_CEO and FAM_DIR are significant and negative,
suggesting that having family members as CEOs or on the board of directors can better align
managers’ interests with those of controlling families, resulting in less audit risk and, therefore,
lower audit fees. In addition, we find that the coefficients on FAM_OWN are significant and
negative, but those on FAM_VC are significant and positive. These results indicate that less severe
Type I agency problems (proxied by FAM_OWN) reduce family firms’ audit risk, while more
severe Type II agency problems (proxied by FAM_VC) increase their audit risk and, therefore,
audit fees.
Our results for control variables are generally consistent with prior research (e.g., Ashbaugh et
al. 2003; Chaney et al. 2004; Krishnan and Visvanathan 2009). For example, audit fees are
positively associated with firm size (LTA) and complexity (ATURN, CURR, and FORGN). In
addition, audit committee characteristics have a significant impact on firms’ audit fees. Specifically,
firms with a larger audit committee (ACSIZE) or more active audit committee (ACMT), on average,
incur higher audit fees, suggesting that large and active audit committees tend to elicit greater
efforts from their auditors and therefore are associated with higher audit fees (Krishnan and
Visvanathan 2009).

ADDITIONAL ANALYSIS

Alternative Definitions of Family Firms

To examine the sensitivity of our empirical results, we run regression analyses by using
alternative definitions of family firms, which include classifying family firms as those in which

24
In the robustness checks, we exclude the observations from year 2000 and find the results similar to the main
results. In addition, we exclude observations from the financial crisis period (i.e., year 2008) and also observe
qualitatively similar results.
25
The p-values for the pairwise tests are less than 0.001.

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86 Ho and Kang

TABLE 5
Family Firms and Audit Fees

Panel A: Firms Choosing Big N Auditors (Dependent Variable: LAFEE)

Model 1 Model 2 Model 3
Independent Variable Coeff. p-value Coeff. p-value Coeff. p-value
Intercept 3.335 0.000 3.537 0.000 3.566 0.000
FAM 0.135 0.000
FAM_NDUAL 0.155 0.000
FAM_DUAL 0.134 0.000
F_CEO 0.095 0.001
H_CEO 0.039 0.056
FAM_DIR 0.334 0.000
FAM_OWN 0.032 0.067
FAM_VC 0.005 0.033
LTA 0.565 0.000 0.564 0.000 0.559 0.000
ATURN 0.036 0.000 0.035 0.000 0.036 0.000
DA 0.154 0.000 0.177 0.000 0.179 0.000
CURR 0.615 0.000 0.652 0.000 0.646 0.000
QUICK 0.062 0.000 0.061 0.000 0.061 0.000
ROA 0.421 0.000 0.644 0.000 0.647 0.000
LOSS 0.162 0.000 0.157 0.000 0.139 0.000
ROA  LOSS 0.533 0.000 0.696 0.000 0.601 0.000
SUB 0.036 0.000 0.036 0.000 0.036 0.000
FORGN 0.284 0.000 0.283 0.000 0.284 0.000
OPIN 0.115 0.000 0.117 0.000 0.116 0.000
NAFEE 0.627 0.000 0.622 0.000 0.635 0.000
TENURE 0.003 0.000 0.003 0.000 0.003 0.000
BUSY 0.111 0.000 0.115 0.000 0.126 0.000
BI 0.039 0.198 0.033 0.303 0.025 0.704
CEOCHR 0.016 0.277 0.016 0.263 0.017 0.199
ACEXP 0.013 0.279 0.015 0.636 0.016 0.602
ACMT 0.018 0.000 0.019 0.000 0.019 0.000
ACSIZE 0.021 0.001 0.025 0.001 0.024 0.001
ACOUT 0.057 0.219 0.057 0.212 0.071 0.155
INST 0.090 0.000 0.099 0.000 0.100 0.000
CEOHOLD 0.003 0.014 0.003 0.013 0.002 0.114
DIR 0.119 0.091 0.121 0.095 0.126 0.096
IMR 0.658 0.000 0.634 0.000 0.593 0.000
Adj. R2 0.821 0.822 0.822
Year Fixed Effects Controlled
Industry Fixed Effects Controlled
Observations 8,777

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 87

TABLE 5 (continued)

Panel B: Firms Choosing Non-Big N Auditors (Dependent Variable: LAFEE)

Model 1 Model 2 Model 3
Independent Variable Coeff. p-value Coeff. p-value Coeff. p-value
Intercept 2.066 0.000 1.770 0.000 1.558 0.000
FAM 0.119 0.007
FAM_NDUAL 0.129 0.000
FAM_DUAL 0.109 0.028
F_CEO 0.278 0.000
H_CEO 0.334 0.502
FAM_DIR 0.676 0.002
FAM_OWN 0.203 0.010
FAM_VC 0.339 0.000
LTA 1.200 0.000 1.233 0.000 1.369 0.000
ATURN 0.124 0.007 0.166 0.001 0.129 0.002
DA 0.023 0.858 0.137 0.549 0.406 0.223
CURR 0.258 0.086 0.267 0.084 0.348 0.022
QUICK 0.065 0.000 0.071 0.000 0.069 0.000
ROA 0.388 0.002 0.349 0.000 0.473 0.005
LOSS 0.356 0.000 0.336 0.000 0.341 0.000
ROA  LOSS 3.094 0.000 4.110 0.000 4.664 0.000
SUB 0.030 0.200 0.024 0.523 0.009 0.714
FORGN 1.801 0.000 1.972 0.000 2.104 0.000
OPIN 0.126 0.024 0.118 0.030 0.127 0.025
NAFEE 0.923 0.000 0.814 0.000 0.864 0.000
TENURE 0.001 0.669 0.005 0.230 0.003 0.715
BUSY 0.078 0.367 0.191 0.164 0.050 0.567
BI 0.012 0.945 0.116 0.441 0.156 0.514
CEOCHR 0.226 0.017 0.274 0.003 0.356 0.001
ACEXP 0.060 0.022 0.061 0.010 0.103 0.000
ACMT 0.024 0.010 0.025 0.022 0.022 0.039
ACSIZE 0.062 0.055 0.046 0.063 0.069 0.000
ACOUT 0.170 0.483 0.152 0.279 0.166 0.510
INST 0.047 0.776 0.021 0.645 0.129 0.390
CEOHOLD 0.038 0.003 0.042 0.000 0.057 0.000
DIR 0.867 0.048 0.904 0.023 1.163 0.008
IMR 2.305 0.003 2.475 0.001 2.872 0.000
Adj. R2 0.803 0.810 0.831
Year Fixed Effects Controlled
Industry Fixed Effects Controlled
Observations 442
The p-values are two-tailed and based on standard errors clustered by firm.
See Appendix A for variable definitions.

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88 Ho and Kang

TABLE 6
Alternative Definitions for Family Firms
Family Firm Criteria
5 Percent and
5 Percent and 5 Percent Sitting on the
Sitting On and Top Board and Top 20 Percent
the Board Management Management Ownership
Regression Results Coeff. p-value Coeff. p-value Coeff. p-value Coeff. p-value
Percent of family firms in 21.3% 6.6% 6.5% 8.4%
the sample
FAM in the audit choice 0.191 0.003 0.152 0.039 0.163 0.038 0.108 0.021
model
FAM in the audit fee model 0.154 0.000 0.127 0.000 0.125 0.000 0.103 0.000
for Big N Clients
FAM in the audit fee model 0.245 0.011 0.217 0.013 0.273 0.008 0.080 0.004
for non-Big N clients

Family Owners Family Owners

as the Largest Not the Largest
Regression Results Coeff. p-value Coeff. p-value
Percent of family firms in the sample 7.7% 30.7%
FAM in the audit choice model 0.183 0.043 0.106 0.028
FAM in the audit fee model for Big N Clients 0.152 0.000 0.095 0.000
FAM in the audit fee model for non-Big N clients 0.265 0.042 0.064 0.039
The results are abbreviated. The p-values are two-tailed and based on standard errors clustered by firm.

founding family members are both key executives and blockholders; those in which founding
family members are both directors and blockholders; those in which founding family members are
key executives, directors, and blockholders; or those in which founding family members own at
least 20 percent of the firm’s stocks. As shown in Table 6, our main results remain qualitatively
similar. We also decompose family firms into those with family owners as the largest shareholders
and those with others as the largest shareholders. Our results show that both groups of family firms
are less likely to hire top-tier accounting firms and incur lower audit fees than non-family firms, and
the tendency to hire non-Big N auditors and to pay lower audit fees is more significant for firms in
which family owners are the largest shareholders.

Family Firms’ Choice of Industry Specialist Auditors

Besides the brand name reputation as designated by Big N and non-Big N auditors, we also
examine family firms’ auditor choice along another dimension, i.e., industry-specialist auditors.
Due to their industry-specific knowledge, industry-specialist auditors are able to assist clients in
enhancing disclosure quality. Moreover, Reichelt and Wang (2010) find empirical evidence that
audit quality is higher when the auditor is both a national and city-specific industry specialist.
Following their research, we classify an auditor as an industry specialist if it maintains industry
expertise at both national and city levels. Our untabulated results show that family firms are less
likely to choose industry-specialist auditors, which is consistent with our prior argument that the

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 89

effect of Type I agency problems dominates that of Type II agency problems, resulting in lower
demand for high-quality audits by family firms than non-family firms.

Robustness Tests26
The Effect of Internal Control Weakness
Hogan and Wilkins (2008) document that auditors charge higher audit fees to firms that
disclose internal control weakness under the provisions of SOX, as these firms tend to have higher
levels of inherent risk and information risk. In addition, prior literature has shown that, compared to
non-family firms, family firms have a higher likelihood of internal control material weakness due to
their unique ownership structure (Wu et al. 2010). In light of the prior studies, we include in both
auditor choice and audit fee models, a variable that captures the effect of internal control material
weakness. Untabulated results show that the impact of family ownership (FAM) on firms’ auditor
choice and audit fees remains significant and negative in both models after controlling for the effect
of internal-control deficiency.

Other Robustness Tests

In addition, we use different sampling and estimation techniques to conduct robustness checks.
First, we repeat our data analysis by using a matched sample for family-firm observations.
Specifically, we match each family-firm observation with a non-family firm from the same two-digit
SIC code and year with the closest firm size. We find untabulated results qualitatively similar.
Second, we apply a two-stage probit least squares (2SPLS) regression to examine the effect of firm
leverage on auditor choice.27 Again, our untabulated results confirm that the likelihood of choosing
Big N auditors for family firms is significantly lower than that of non-family firms. Finally, we
repeat our main analysis separately for S&P 500, S&P MidCap 400, and S&P SmallCap 600 firms,
as well as for pre- (2000–2001) and post-SOX (2002–2008) periods. We find results for all the
subsamples similar to those for the full sample.

CONCLUSION
Although the literature on auditor choice and audit fees is well developed, the relations
between family firms and auditor choice and audit fees are less established. Our research spans
2000–2008 and shows that, on average, family firms are less likely to hire Big N auditors. Our
additional results indicate that firms with active family control (i.e., family members as CEOs or on
the board) are especially reluctant to appoint Big N auditors. Regulators have raised concerns that
the post-SOX period would give rise to a lack of competition among Big 4 accounting firms (Cox
2005; McDonough 2005), but our findings that family firms have a lower likelihood of hiring Big N
auditors may at least partially alleviate such concerns. Our results also show that family firms incur
lower audit fees than non-family firms, which is driven by their lower audit risk and demand for
external auditing services. Our results are robust to alternative definitions of family firms, and we

26
All the results in this section are untabulated and available upon request.
27
Recent studies (Mansi et al. 2004; Pittman and Fortin 2004) report that auditor choice affects a firm’s cost of debt
and target debt ratio, suggesting there is a potential reciprocal causal relation between auditor choice and
leverage. Therefore, we use the 2SPLS regression to control for potential endogeneity between auditor choice
and leverage. Specifically, in the first-stage regression, we predict firm leverage using firm size, fixed assets, tax
shields, sales growth, ROA, R&D expenses, and an indicator variable for manufacturing industry (Titman and
Wessels 1988). And in the second stage, we incorporate the variable of predicted firm leverage from the first
stage into our auditor choice model.

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90 Ho and Kang

find that the tendency to hire non-Big N auditors and to pay lower audit fees is more significant for
firms in which family owners are the largest shareholders.
We believe our findings on the empirical link between auditor choice and audit fees enhance
our understanding of the effect of ownership structure in financial reporting and the audit planning
process. As pointed out by Carcello et al. (2002), there has been heightened interest among
accounting professionals, the business community, and regulators in the relation between corporate
governance and financial reporting quality, and the relationships between corporate governance
mechanisms and the audit process have been a fruitful area of inquiry. Our results suggest that
ownership characteristics, as part of the governance mechanism, constitute an important
determinant of auditor selection and audit effort and, therefore, have both policy and practical
implications for the demand and supply of audit services to firms with different ownership
structures. First of all, our study provides policymakers and practitioners with critical insight into
differences in auditor selection criteria between family and non-family firms and differences in the
severity of their Type I and II agency problems. Our empirical evidence also sheds light on how
family firms view and value the external audit and whether they are selecting auditors on price, or
quality, or some combination of these factors. In addition, given the current downward trend in
audit revenues as a percentage of total revenues, our findings could lead accounting firms to
re-examine how they market audit services to family firms.

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Auditor Choice and Audit Fees in Family Firms: Evidence from the S&P 1500 93

APPENDIX A
Variable Definitions
BIGN ¼ 1 if the firm hires a Big N auditor, and 0 otherwise;
AFEE ¼ audit fees in thousands;
LAFEE ¼ natural logarithm of audit fees;
TA ¼ total assets in thousands;
LTA ¼ natural logarithm of total assets;
CHTA ¼ absolute value of change in total assets from the previous year;
ATURN ¼ assets turnover, measured as sales divided by total assets;
DA ¼ long-term debts divided by total assets;
CURR ¼ current assets divided by total assets;
QUICK ¼ current assets minus inventory divided by current liabilities;
ROA ¼ earnings before extraordinary items divided by lagged total assets;
LOSS ¼ 1 if net income before extraordinary items is less than zero, and 0 otherwise;
SUB ¼ square root of the number of subsidiaries;
FORGN ¼ foreign sales as a percentage of total sales;
OPIN ¼ 1 if the firm receives a modified audit opinion, and 0 otherwise;
NAFEE ¼ non-audit fees divided by total fees paid to the auditor;
TENURE ¼ the number of years of the auditor-client relationship;
BUSY ¼ 1 if the firm’s year-end is between December and March, and 0 otherwise;
BI ¼ the percentage of independent directors on the board;
CEOCHR ¼ 1 if the CEO is also chairman of the board, and 0 otherwise;
ACEXP ¼ 1 if the firm’s audit committee has at least one financial expert, and 0 otherwise;
ACMT ¼ the number of audit committee meetings;
ACSIZE ¼ the total number of directors on the audit committee;
ACOUT ¼ 1 if the audit committee has solely independent directors, and 0 otherwise;
INST ¼ the percentage of shares held by institutional investors;
CEOHOLD ¼ the percentage of shares held by the CEO;
DIR ¼ the percentage of shares held by outside directors;
FAM ¼ 1 if the firm is classified as a family firm, and 0 otherwise;
FAM_DUAL ¼ 1 for family firms with dual-class shares, and 0 otherwise;
FAM_NDUAL ¼ 1 for family firms without dual-class shares, and 0 otherwise;
F_CEO ¼ 1 for family firms with family member CEOs, and 0 otherwise;
H_CEO ¼ 1 for family firms with hired-hand (non-family member) CEOs, and 0 otherwise;
FAM_DIR ¼ the percentage of family member directors on the board;
FAM_OWN ¼ the percentage of common stock owned by family members;
FAM_VC ¼ the percentage of excess voting rights over cash flow rights held by family members;
IMR ¼ inverse Mills ratio;
u ¼ industry-specific fixed effects (two-digit SIC code); and
d ¼ year-specific fixed effects (2001–2008).

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