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A significant body of prior research has shown that audits by the Big 5 (now Big 4) public accounting firms are quality differentiated relative to non-Big 5 audits. This result can be derived analytically by assuming that Big 5 and non-Big 5 firms face different loss functions for “audit failures” and is consistent with a variety of empirical evidence from studies of audit fees, auditor changes, and the stock price reaction to audited earnings. However, there is no existing evidence (of which we are aware) concerning the underlying production differences between Big 5 and non-Big 5 audits. As a result, existing empirical evidence cannot distinguish between the possibility that Big 5 audits are simply perceived to be different (e.g., by investors) or actually differ in how they are produced. Our research objective is to identify the production characteristics of audit engagements that may explain the differences in expected audit quality between Big 5 and non-Big 5 firms. In this archival study, we examine the total audit effort and the allocation of effort to four audit phases—planning, (control) risk assessment, substantive testing, and completion—for a cross-section sample of 113 audits of Dutch companies in 1998/99 by 14 public accounting firms. We find that, after controlling for client characteristics: (1) both types of auditors exert about the same amount of total audit effort; (2) Big 5 auditors allocate relatively more effort to planning and (control) risk assessment, and relatively less to substantive testing and completion; and (3) client size, use of the business-risk-based audit approach, and reliance on client internal controls affect audit hours differently for the two auditor types. We conclude that the Big 5 firms actually produce a higher audit quality level, and that this quality difference is related to how audit hours are deployed in a more contextual and less procedural audit approach.

In this paper, we examine the relative efficiency of audit production by one of the then Big 6 public accounting firms for a sample of 247 geographically dispersed audits of U.S. companies performed in 1989. To test the relative efficiency of audit production, we use both stochastic frontier estimation (SFE) and data envelopment analysis (DEA). A feature of our research is that we also test whether any apparent inefficiencies in production, identified using SFE and DEA, are correlated with audit pricing. That is, do apparent inefficiencies cause the public accounting firm to reduce its unit price (billing rate) per hour of labor utilized on an engagement? With respect to results, we do not find any evidence of relative (within‐sample) inefficiencies in the use of partner, manager, senior, or staff labor hours using SFE. This suggests that the SFE model may not be sufficiently powerful to detect inefficiencies, even with our reasonably large sample size. However, we do find apparent inefficiencies using the DEA model. Audits range from about 74 percent to 100 percent relative efficiency in production, while the average audit is produced at about an 88 percent efficiency level, relative to the most efficient audits in the sample. Moreover, the inefficiencies identified using DEA are correlated with the firm's realization rate. That is, average billing rates per hour fall as the amount of inefficiency increases. Our results suggest that there are moderate inefficiencies in the production of many of the subject public accounting firm's audits, and that such inefficiencies are economically costly to the firm.

Abstract. This paper examines the portfolio problem of an auditor who controls the level of audit quantity and then combines investments in general market securities with investments in risky audits. We note that an auditor cannot simply choose audits to add to the portfolio but, rather, that a portfolio is constructed indirectly through a process of bidding against competitors. Thus, our analysis yields a bidding function that provides an estimate of the minimum fee an auditor is willing to accept to serve a potential new client, given existing investments. We develop propositions conceming ttie effects of various portfolio characteristics on the fee bid. Finally, we discuss the possible impact of a portfolio view of audit risk upon the structure of the auditing industry.