Audit Market Structure and Audit Pricing

Abstract

SYNOPSIS Extant literature finds mixed evidence on the association between audit market concentration and audit fees. We re-examine this issue using a large sample of U.S. audit clients covering 90 metropolitan statistical areas (MSAs) spanning 2000–2013. We find that audit market concentration is associated with significantly higher audit fees, consistent with the concerns of regulators and managers. We also find that increases in audit market concentration are associated with fewer initial engagement fee discounts (i.e., reduced lowballing), particularly for non-Big 4 clients. We reconcile our findings with those of prior research and find that our divergent findings are attributable to controls for MSA fixed effects. In supplemental analyses, we find that audit market concentration is associated with higher audit quality. We also find that concentration is associated with higher audit quality for first-year engagements, but only if the auditor does not lowball on the engagement. Our results are relevant to the ongoing debate regarding the consequences of increased concentration within the U.S. audit market (GAO 2003, 2008). JEL Classifications: M41; M42; L13.

The effect of audit market structure on audit quality and audit pricing in the private‐client market

“…This study's evidence on the pricing and quality effects of market structure in the private‐client segment of the audit market thus contributes to a more comprehensive understanding of how audit market structure affects audit firms' behavior. Finally, by showing that the level of competition varies within a country, across regions, our study confirms the importance of measuring market structure at a local rather than a national level, as done by, for example, Chu, Simunic, Ye, and Zhang (), Eshleman and Lawson (), and Numan and Willekens ().…”

“…Numan and Willekens () find the same for a sample of US listed firms, while considering local, industry‐segmented audit markets. In contrast, some studies find a positive association between (local) market concentration and audit pricing in various types of audits: in Canadian municipal audits by non‐Big 6 firms (Bandyopadhyay & Kao, ), in Chinese public‐client audits (Huang, Chang, & Chiou, ), and in US public‐client audits (Eshleman & Lawson, ).…”

“…The omission of economic factors that jointly determine market structure and audit pricing from the analysis may at least partly explain the inconclusiveness of prior evidence. For example, Eshleman and Lawson () show that in the US market, controlling for previously omitted regional audit pricing factors changes the estimated effect of market concentration on audit fees from negative to positive. Further, studies comparing audit firms' pricing power over time are unavoidably affected by potentially confounding changes in other determinants of pricing power, such as regulatory or economic developments (see, e.g., Maher, Tiessen, Colson, & Broman, ).…”

The Effects of State-Level GAAP Regulation on Municipal Audit Markets, Reporting Quality, and Audit Fees

“…Using oligopolistic theories, traditional economic arguments suggest pricing rises with concentration (Weiss 1989). Eshleman and Lawson (2017) find that greater auditor concentration in U.S. metropolitan statistical areas is associated with higher audit fees. However, the auditing markets included in our study are competitive, and similar to findings of regulators (GAO 2003(GAO , 2008, do not contain levels of concentration sufficient to suggest evidence of collusive pricing.…”

Small is big! The role of ‘small’ audits for studying the audit market

“…However, such empirical evidence Small is big! The role of 'small' audits for studying the audit market have not been able to establish any clear regularity about the relationship between market concentration and audit fees and audit quality -for references on audit fees, see Eshleman and Lawson (2017); for references on audit quality, see DeFond and Zhang (2014).…”