Audit Fees and Client Industry Homogeneity

Abstract

SUMMARY This study examines the relationship between a client industry's homogeneity and audit fees. We assume that audit efficiencies occur in audits in industries whose members have similar operations and, therefore, are where auditors benefit from the use of similar audit procedures and experience lower average audit costs. To identify industries with similar operations, we use operational expense homogeneity, which is based on the correlations between the changes in operating expenses among industry members. Adapting a standard fee model (Hay, Knechel, and Wong 2006), we find that homogeneity is negatively associated with audit fees. Further, we find that specialist auditors charge lower fees in homogenous industries. Finally, we observe a lower standard deviation of fees in more homogenous industries. Together, these results suggest that auditors sustain lower costs in audits of homogenous clients and that the similarly lower costs incurred across auditors are passed on to clients in the form of lower fees. Data Availability: Data used in this paper are available from the sources listed in the paper.

Audit Market Concentration and Audit Fees: An International Investigation

“…With such expertise, auditors are able "to develop expertise-related economies of scale that allow them to maintain relatively low fees" (Pearson and Trompeter 1994, 116). Bills, Jeter, and Stein (2015), Cahan, Jeter, and Naiker (2011), Cairney and Stewart (2015), and Fung, Gul, and Krishnan (2012) also provide evidence supporting the argument that expertise allows auditors to provide their services at lower fees, at least in some industries. Similar to this view, Yardley et al (1992) explain that the dominant auditors are able to develop efficiency gains.…”

“…Separately, Pearson and Trompeter (1994) investigate the association between audit market concentration and audit fees with a limited number of samples that belong to the life and health insurance industry and the property and casualty insurance industry. Alternatively, Cairney and Stewart (2015) and Numan and Willekens (2012) use audit market concentration as a control variable in their analyses on the determinants of audit fees. While Numan and Wilekens (2012) document a negative coefficient on the audit market concentration, Cairney and Stewart (2015) report mixed results.…”

“…Alternatively, Cairney and Stewart (2015) and Numan and Willekens (2012) use audit market concentration as a control variable in their analyses on the determinants of audit fees. While Numan and Wilekens (2012) document a negative coefficient on the audit market concentration, Cairney and Stewart (2015) report mixed results. Thus, the findings in these two studies are also mixed at best.…”

The Effect of Industry Homogeneity on the Magnitude of Post-Earnings Announcement Drift: Evidence from Korea

“…This means that audit efficiency improves in good environmental conditions in which a certain client's information such as financial structure or accounting practice is likely to have reference to other clients. Cairney and Stewart (2015) and Bills, Jeter and Stein (2015) support the argument on audit efficiency through the spillover effect by showing that auditors lower fees for clients in industries with similar operations in which industry knowledge is likely to be transferable.…”

“…Cairney and Young (2006) proposed the homogeneity measure in operation as the average correlation in changes in operating expenses of each firm in the same industry and reported that industry homogeneity is associated with audit specialisation. By extending Cairney and Young (2006), several papers examined the reason for the relationship and found that auditors are likely to be specialised in greater homogeneous industries because cost competition exists due to knowledge spillover effects when auditing similar clients in financial structure or accounting policy (Cairney & Stewart, 2015;Bills et al, 2015). These results indicate that the information environment with greater industry homogeneity improves audit efficiency.…”