The Effect of Small Firm Product Space Location on Audit Market Competition and Differentiation

• In Event: Local and Office Level Audit Markets

Abstract

In this paper we examine how small audit firms compete by studying the viability of product space location choice as a differentiation strategy in the U. S. small firm audit market. We argue and document that industry specialization is a viable location choice also for small audit firms and test the effect of two location choices of small audit firms: 1) a small audit firm’s industry location choice relative to other competing small audit firms, and 2) its industry location relative to large audit firms in the same MSA. We find that small audit firms can successfully differentiate themselves from other small-firm competitors through the two methods examined. First, we provide evidence that audit fees are increasing in the degree of market share differentiation achieved relative to other small-firm auditors. Second, we find that audit fees are increasing in the degree of market alignment achieved with large audit firms. We also find that the degree of market alignment achieved with large firms is not only associated with the small firm’s audit fees, but is also negatively associated with the fees charged by the large firm incumbent auditor. We find that this negative association with the large firm’s fees are incremental to the reduction in fees caused by other large-firm competitors. These results suggest that product space location choice can be an effective differentiation strategy in the small firm audit market segment.

Authors

• Kenneth L Bills, Colorado State University

• Nathaniel Martin Stephens, Utah State University

• Marleen Willekens, Katholieke Universiteit Leuven