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Internal Control Risk and Initial Audit Pricing.

We examine whether the practice of initial audit fee discounting persists for high internal control risk clients. Auditing standards require auditors to use a risk-based approach to conduct and price their audits, yet we predict the intense price competition for new audits dominates control risk pricing effects. Consistent with our prediction, we find initial audits of clients that disclose a prior year material weakness in internal control over financial reporting (MW) receive significant fee discounts relative to ongoing engagements. Further, the fee discounts do not impair audit quality, measured using accruals quality and restatements. Additional tests reveal that prior year MW-initial audit fee discounting is strongest among clients: with no current MW, audited by Big 4 firms, in high audit competition markets, audited by auditor specialists, and during non-crisis periods. We contribute to both the regulatory debate regarding initial audit fee cutting and the initial engagement literature by shedding light on the prevalence and consequences of initial audit fee cutting for high control risk clients.