Client Competition, Auditor Specialization, and Audit Quality

• In Event: Continental Breakfast - Research and Education Forum
  In Roundtable Session: Table 8: Banking and Industry Specialization

Abstract

Summary: Research has shown that client characteristics are a determinant in the demand for audit services whether it is the demand for a Big 4 auditor, a specialist or a low cost provider. Clients in competitive industries have additional incentives to manage earnings than clients in non-competitive industries in order to keep up with their competitors which may play a major role in their negotiations with the auditor. I expand on the client concentration research by investigating the effect of client competition on audit fees and audit quality and find evidence that auditors view clients differently depending on whether or not they are in a competitive industry or management perceives they operate in a competitive environment. Competitive clients bargaining power is stronger for those who perceive they operate in a competitive environment than for those who do operate in a competitive industry. My results indicate that auditors have more bargaining power and charge higher audit fees for clients in competitive industries who they deem as riskier. More importantly, audit quality for the competitive client, whether actual or perceived, is much lower than non-competitive clients indicating that they are able to manage earnings to maintain earnings targets. However, when the competitive client uses a specialist, an audit premium is charged but they are unable to fully curtail management’s ability to manage earnings.

Author

• Elizabeth Schwartzhoff, Louisiana State University