Abstract. Low-ballingstrategy inthe audit market of China is very common, and there exists the cognitivecontradiction between the auditor and the listed companies on the economic value of audit products. Weanalyze the demand pattern and efficiencyof audit services in China based on three core hypotheses of the audit demands, explores the driving force of low-balling from demand and supply perspectives, discusses the supervisionefficiency of the Chinese regulatory authorities onLow-balling; and eventually proposes some policy suggestions on regulation respectively from demand, supply and macro litigation environment perspectives.
　　Keywords: Low-balling, Audit DemandSupervision Efficiency, Price Competition
　　1. Introduction
　　Low-balling behavior has not only been a problem faced by national audit practitioners and theorists, but also an important element in the control system of the audit industry. In China, low-balling in the audit service of listed companies is very common (Liu Xia, 2013). On the one hand, auditors complain aboutLow-balling behavior,accusing this behavior compresses industry profit; on the other hand, they continue to lower audit prices to attract customers. While those listed companies that bear the "considerable high" audit fees, hopeto cut down this costs, thereby exacerbating Low-balling,which results in the contradiction between the auditors and the audit clients on the standards of audit pricing. Admittedly, theorists and practitioners did not have conclusions to address this problem, the existing regulatory approach taken by the regulators which emulatessome western countries also did not worksas expected. The reason is a lack of proper analysis and understanding of the intrinsic motivation and the mechanism of low-balling behavior under different institutional backgrounds.
　　Foreign researchers believe that low-balling is a rational competitive reactions of the incumbent auditor who expect to get future quasi-rents(Simon & Francis, 1988), and thestandards of pricing is the cost of auditworkload. Domestic regulatory authorities' judgment for low-balling is based on the established price standardset by Commodity Price Management Department and the Ministry of Finance; while academics did not have a unified clear definition and relatively systematical study on this. Unlike low-balling strategies in foreign countries, domestic auditors complained that the harsh competitive environment is unfavorable to their own interests, which does not necessarily mean that audit feesis really less than the cost of auditing practicethat results inCPA firms' losses. Instead,as the expansion of CPA firm size, increasing stuff, and growing revenue we have observed, this complaint may mean the decline of profit margin (Cui Hong, 2008). 　　In an efficient audit market, audit services obtain its economic value as the positive externality. The key prerequisite for its economic valuerealizationis the sufficient and effective demand in audit market. Price is the external manifestation of economic value. The process of engagement contracting, purchase audit products, pay the audit fees for listed companies should base on their audit demand and the recognition of its economic value.Thus,the audit demanders and suppliers could reach an agreement on audit price. Ifthere is a conflict on the audit pricebetween the suppliers and demanders, it means there is a big difference on perception of the economic value of the audit product. China's audit market is in astatus of lacking in high-quality customer resources(PengHuarong, Xiang Jinjin, 2011) and high-quality audit demands (DeFond, et al, 1999; Liu Feng, Zhang Limin, LeiKeluo, 2002; Zhu Hongjun et al, 2004); the enhancement ofaudit independence deviates from the audit market share(DeFond et al., 2000);so low-balling becomes inevitable. We analyze the demand patterns and effectiveness of the audit services in Chinese audit market fromthree core hypotheses of audit demands, and explore the driving forces of low-balling in the following sections.
　　2. The barriers ofaudit economic value realization: lack of efficientaudit demand
　　The key prerequisite of the economic value realization of audit is efficientaudit demand. To sum up the domestic and foreign research on audit demand,there are three core hypotheses of audit demand: agency theory, information theory andinsurance theory, which interprets the audit economic value from different angles.
　　Agency theory, based on Jensen &Meckling (1976) principal-agency theory, emphasizes that audit is an endogenousdemand of reducing agency cost between the principal and the agent, so it can give us a more reasonable explanation of the operation mechanism of modern enterprisesfrom the micro perspective of a company. However,as the immaturestage of the development of Chinese joint-stock company,features such as both "absence of owners","insider control" in state-owned enterprises and "family control" in private enterprisescould lead to the failure of the establishment of triangular relationship amongclients - agents – Auditors in Chinese audit market, which triggers the inexistenceof efficient audit demand based on agency theory in China.
　　Information Theory includes "signaling effect"and "view of information systems" from the middle-level perspective of audit market.The former believesthat companies treat audit as a signaling mechanism of distinguishing the "good" and "bad" companies in the stock market; while the latter treats audit as a tool of enhancing the company's financial information credibility for establishing capital market's confidence (Tom Lee, 1993). Some findings based onInformation Theory support the existence of the effective information demand of high-quality auditoffinancial information users (Pan Keqin, 2010) For example, the earnings response coefficient(ERC) is relatively higher in those listed companies who hire higher quality auditors(Toeh& Wong, 1993), and their market reaction is more positive and active. Therefore, audit demand based on Information Theory is effective in the Chinese audit market to some extent. 　　Insurance Theory considers auditor as a "deep pocket" under the compensation systemand one of the transferring mechanismsof the financial statements risk based on the Risk Transferring Theory. However, the prerequisite of the realization of audit insurance value should base on the following conditions:①Financial information users have the rights to sue the auditors; ②Auditors have the capability for the compensation(Kellog, 1984; Stice, 1991). When it goes to the audit market of China, the absence of litigation mechanisms towards Chinese firms will lead to a significantly reduction ofmanagers' motivation of legal liability's removal through hiring high quality auditors(audit insurance demand) (Yu Xiaoming, 2000; Zhuang Kai, 2006), so insurance demandbecomes invalid.
　　In summary, bothagency demand and insurance demand for audit is not sufficientfor Chinese listed companies. Although theinformation demand for Big 4is obvious, thiseffective information demand could not be fully reflected in domestic accounting firms. Deficient audit demand and the mandatory requirement of auditservices by the government(Hanwen Chen, 2007)derivethe extremely low audit economic value and audit independence. Based on the above analysis,it is not difficultfor us to understand the complaining about high audit fees by listed companies and theirdesires to depress the audit fees. Thus, lack of effective audit demand is the main driving force of low-balling.
　　3. Helplessness of audit market Low-balling: price game of audit services
　　Foreign researchers believe that low-balling is not only an inevitable consequence of the audit market competition, but it will also have an impact on the competitionin turn (Hermanson et al, 1987; Elitzur,1996; Chan,2001).But there are mixed findings for the influence on audit quality and audit independence caused by low-balling. Similarly, domestic research onlow-balling in China ismixed. On the one hand, low-balling is theconsequence of trade-offfor the demanders and suppliersinboth short and long term benefits and litigation risk(Cui Wang,2008). China's audit market is full of competition(Xia Donglin, Lin Zhenze, 2003), and the traditional audit services are oversupplied (YaorongHui, Cui Maolin, 2008).Low-balling is a "Nash Equilibrium" status after the gaming between thefirms and auditors (WengJianying , 2008), as there is no inevitableeffect on audit quality and audit independence by low-balling(Cui Hang, 2008), even a positive incentive to audit quality does exist (Lee and Gu, 1998). On the other hand, lowlitigationrisk created by imperfect legal system reduces auditor's consideration of litigation losses in the process of pricing negotiationswith listed companies (Wang Junfa, Guan Xu, 2011).At the same time, China' simperfect burden of proof systemalso leads to thelack of motivation of implementing the proof procedures for investors, which result in an increase inlitigation costs against auditors' negligenceand the lower auditors' liability of compensation(Liu Feng, XuFei, 2002), which further creates opportunities and spaces for malicious low-ballingand undermines the auditor's independence. In summary, the audit market competition structure does not solelylead to the conclusion that low-balling damages auditindependence. on the contrary, the lack of binding power oflegal liability and litigation risks faced by the auditorscould actually lead to thereduction of audit independence and low-balling behavior. 　　4. Another driving force of low-balling in audit market: Audit delegation pattern of audit service
　　As the economic depression of US, AICPA started to allow auditors to undertake the business by tendering in 1970s. Comparatively, the audit bidding system emerged in 1990s in China. The economic substance of audit tendering is the auction of audit products (Min Wu, Yusheng Kong, 2010), which itself will derive low-balling substantially (Garsombke&Armitage, 1993; Tiao Li, 2005; Yi Li, 2006; Bo Liu, 2013). Regulatory authorities, such as Ministry of Finance and CICPA, respectively issued "Regulations on Delegation of Audit Tendering to CPA Firms" and "Instruction of CPA Firms Engaging in Audit Services by Audit Tendering", but both of them had little effect.
　　On the demand side of audit service, as the existence of imperfect governance structure of listed companies in China, managers obtain the opportunities bypassing the shareholders and become the substantial principal of audit service, which leads to the result that bidding system cannot fundamentally change audit tendering pattern. Meanwhile, the inequality between auditors and clients also fails to guarantee the independence of auditors. Secondly, the duality of state-owned enterprise tenderees (both the state-owned assets owners and the government regulators) could also derive both "geographical segmentation" of audit services (Limin Zhang, Jinsong Guan, 2004) and "local protectionism" (FenlingGu, 2005; Tiao Li, 2005).On the supply side of audit service, the arrangement of audit tendering will make auditors succumb to the pressure of survival and sequentially spark Low-balling (HuaBai, 2005). Immature litigation environment and flawed lawsuits system make auditors tend to behave opportunistically, overlook the audit risk, and initiate malicious bid for undertaking business. In conclusion, the existence of defects of audit tendering pattern is the main driving force of low-balling in Chinese audit market. Different from the economic consequences of price gaming between suppliers, public bidding system could exacerbate the damage of audit independence on the basis of lack of effective audit demand.
　　5. Failure of audit market: supervision
　　efficiency on low-balling
　　Theoretically, Information Theory provides appropriate reasons of regulatory authorities on audit factors based on market failure:
　　The conflict between the economic feature of audit product and interest of listed companies. In the context of mandatory audit in Chinese audit market, we have to consider that listed firms who pay for the audit expense could not obtain the benefits of disclosure of audit reports. Therefore, regulations should be introduced to ensure the standards of audit quality (Ledyard, 1991). 　　Information asymmetry makes it difficult to detect the collusion of auditors and listed firms, so regulations should be introduced to help financial report users avoid losses (Weiying Zhang, 2002). No matter what kind of regulatory measures are adopted, the main function and role of government regulation is filling the gaps rather than replacement of imperfect audit market mechanism.
　　Regulations on low-balling once originated from the worries about independence reduction in US (AICPA, 1978; U.S. Senate, 1977). Although it is neither approved nor advocated by US regulators, SEC did not prohibit low-balling whereas audit price still adjusted by audit market. Yet, mandatory disclosure of audit fees could constrain low-balling (Dye, 1991).
　　In China, the causality between low-balling, auditor independence, and audit quality is still need to be clarified, i.e. does low-balling undermine the independence of the audit, or the lack of independence triggers a Low-balling. Thus, effective regulation mechanism should base on the correct understanding of this causality. We believe that low-balling should not be the purpose and means of government supervision; on the contrary, the key objective of regulation should be ensuring auditor independence and audit quality. However, the government-led mixed regulation mode of our country still has the following problems unsolved:
　　In general, China's audit market is facing serious fragmented regulatory framework (FenlingGu, 2005). The coordination cost among various supervisors is relatively high and the regulatory authority on both audit supply and demand are unclear. Mixed and various regulatory authority standards of Ministry of Finance, SASAC (State-owned Assets Supervision and Administration Commission), CSRC (China Securities Regulatory Commission), Shanghai and Shenzhen Stock Exchange, and CICPA (Chinese Institute of Certified Public Accountants) for both listed companies and auditors cause the confusions of both to a great extent.
　　Furthermore, the excessive, lagging, and less-flexible regulation of the government which bypasses the self-regulation of audit industry mainly results in the "absence" of industrial self-regulation and the failure of daily monitoring mechanism.
　　If regulatory authorities still believe that the controlling for low-balling can bring us relatively relaxed environment of profit for auditors and prompt auditors to practice regularly, as a matter of fact, the introduced regulation may not work as expected. 　　Government guided-price adopted by domestic auditors does not provide clear and appropriate foundation and basis for price setting (such as business complexity, audit risk, et al.). As one of the indicator of audit fees, the workload is vulnerable to being manipulated. In the absence of reasonable standard for price setting, the criterion whether auditors adopt "low-balling" tactics (whether to improve audit efficiency or only to attract customers) are ambiguous, leaving no logical reason for low-balling regulation. Up to 2010, "The Management Approach of CPA Service Charge", issued by National Development and Reform Commission and Ministry of Finance, still used the government- guided price.
　　For low-balling behavior, both the issuance of official document for low-balling prohibition and industry vows of low-balling boycott have limited practical effects.
　　That international auditors who have excellent client resources adopt price adjusted by market would intensify the unfair practical environment.
　　The bottom line of audit fees set by regulatory authorities sparks auditors to pay the clients commission rebates and take subsidies from non-audit services for the purpose of keeping clients and avoiding regulation.
　　After the enforcement of the policy, regulators did not concern about corresponding response and the actual results on both audit suppliers and demanders.
　　In short, the regulatory efficiency of low-balling has not achieved the expecting effect.
　　6. Conclusions and Recommendations
　　After making a general survey of the controlling measures for low-balling throughout different countries, we could conclude that all of them are based on the purpose of maintaining auditor independence, ensuring audit quality, and purifying market competition environment. However, based on the lack of efficient audit demand, the regulation on low-balling is still defective, let alone the solution of conflict of perceptive audit price between listed firms and auditors.
　　Therefore, we promote that the formulation of regulatory policy should focus on the specification of normalization and rationality of elements in the audit market, including both suppliers and demanders, in order to make the regulatory objectives and functions return from the "price control" to "quality control". We present the following suggestions:
　　6.1 On audit demand perspective
　　It is a long process to let listed companies generate effective audit demand spontaneously in the context of China's transition economy. However, it is of decisive significance for building a healthy audit environment, eliminating low-balling, enhancing audit independence, and maintaining audit quality. 　　Many recommendations on improving corporate governance structure and mechanisms and increasing audit agency demand still need long-term enforcement and test. Meanwhile, enhancing information demands and insurance demands of audit have a relatively high operability.
　　Information demand of audit. Ministry of Finance should align with CSRC (China Securities Regulatory Commission) and Shanghai and Shenzhen Stock Exchanges in order to promote the shareholding reform by enhancing the proportion of tradable shares and accelerating the privatization of state-owned enterprises reform, improve the efficiency of stock market, link up audit report with the entry and exit system of stock marketing compulsively, and arouse the major shareholders' sufficient attention to market capitalization of firms. Furthermore, in response to the cognitive bias that small investors have on the governance function of audit, CICPA (Chinese Institute of Certified Public Accountants), CSRC (China Securities Regulatory Commission), and Shanghai & Shenzhen Stock Exchanges should publicize the positive role of the governance function of auditing to promote investors' and even the entire capital market's attention to auditing.
　　Insurance demand of audit. SASAC (State-owned Assets Supervision and Administration Commission) and the Ministry of Finance could strengthen the supervision frequency on listed companies, highly concern about the underlying causes of auditor switching and "audit opinion shopping" tendency of listed companies, increase the penalties for listed companies when audit failure occurs, and finally realize the value of deactivation and insurance mechanism of auditing. Nevertheless, the above suggestions should be valid on the basis of comparatively perfect litigation environment.
　　6.2 On audit supply perspective:
　　CICPA and Ministry of Finance could draft the regulations on raising auditors' cost of expected loss (e.g. liability) caused by the exposure of audit failure in order to increase the supervision efforts and frequency for boosting the probability of audit failure exposure and compressing the space and intrinsic motivation of low-balling.
　　Low-balling exists in the audit switch of listed companies from large auditors to the smaller ones, which has proved the existence of "firm-on-auditor bully-off" (Hongling Han, Hanwen Chen, 2007). Therefore, CICPA and the Ministry of Finance should further promote the M&A of CPA firms and guide the establishment of non-audit services for small-scale auditors. Furthermore, the industry self-regulation organization could differentiate the competition strategy of CPA firms based on segments of markets and industries of audit clients; meanwhile, the range standard of firm-to-auditor ratio should be mandatory documented to prevent "firm-on-auditor bully-off" or "auditor- on-firm bully-off" to a certain extent. 　　Audit services can play a critical role in investor protection (Choi & Wong, 2002), but the extent of its function will be constrained by the litigation environment (Francis &Khurana, 2001). Therefore, we should promote the maturity process of litigation system of investors protection (such as improving the lawsuit items related to listed firms and auditors for the public investors so that enhance the legally binding faced by listed companies and auditors) to achieve our goal of improving the emphasis of audit suppliers and demanders on economic value of auditing, reducing the conflict on price cognition between suppliers and demanders, eliminating low-balling, and finally enhance the audit quality fundamentally.
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