Transactions Costs and Competition among Auditors in Local Markets

• In Event: Local Markets and Auditor Changes

Abstract

This paper analyzes the role of the transactions costs of changing auditors for the clients of incumbent audit firms that vary in size, on the pricing of audit services by these incumbent firms. We argue that the costs of changing auditors for the clients of small firms are low when there are dominant firms in a market, and these transactions costs increase as the size of the incumbent audit firm increases, being highest for the clients of dominant firms. Using relative audit firm size and market concentration as the proxy measure of transaction costs, we find that audit fees increase as auditor concentration in a market increases, while audit fees decrease monotonically as the size of the audit firm operating in a market decreases relative to the size of the dominant firm in that market and the decrease is more pronounced in more concentrated audit markets. Our evidence is consistent with the argument that the fee premium earned by the dominant audit firms in a market arises from pricing power created by differential transactions costs of changing auditors rather from auditor specialization and quality differentiation between specialist and non-specialist audit firms.

Authors

• Ling Chu, Wilfrid Laurier University

• Dan A Simunic, University of British Columbia

• Minlei Ye, University of Toronto

• Ping Zhang, University of Toronto