Audit Market Structure and Initial Audit Pricing Strategies

• In Event: Audit Markets

Abstract

In this paper we investigate whether the structure of local audit markets affects the pricing of initial audit engagements (i.e., lowballing). We find that when the auditor is located in a more concentrated audit market, discounting of initial audit engagement fees is mitigated. Specifically, a one standard deviation increase in audit market concentration is associated with a 21.1 percent reduction in lowballing. This result is robust to several different specifications. In additional tests, we find that our results are driven by clients switching from a non-Big 4 auditor to a different non-Big 4 auditor. For clients switching from a Big 4 to a different Big 4 auditor, audit market concentration does not appear to affect the initial price discount. Finally, we find that the inclusion of Metropolitan Statistical Area fixed effects is an important determinant of cross-sectional differences in audit fees. Overall, our findings suggest that higher audit market concentration leads to higher audit fees and less lowballing. This finding is relevant to the current debate on the consequences of increased concentration in the audit market (GAO 2003, 2008).

Authors

• Bradley Lawson, Oklahoma State University

• John Daniel Eshleman, Oklahoma State University