Strategic Entry Deterrence in the Audit Industry: Evidence from the Merger of Professional Accounting Bodies

• In Event: Auditors' human capital and labor markets

Abstract

We study how audit firms respond to the threat of entry (as distinct from actual entry) using a quasi-experimental setting, where the recent staggered passage of mergers of three Canadian accounting certification bodies exogenously increases the probability of future entry. Employing difference-in-differences tests with a strict fixed-effects structure (i.e., fixed effects for client firms, audit firms, provinces, and time), we find that the approval of the merger leads to lower audit fees, suggesting that audit firms reduce fees in response to the higher threat of entry. In cross-sectional analyses, we show that the reduction in fees is more pronounced when the merger is expected to induce a greater threat of new entrants ex ante, and is mitigated when such a threat is ex-ante less credible (due to the existence of high entry barriers). The results provide empirical evidence on strategic entry deterrence in the audit industry.

Authors

• Stephanie F. Cheng, University of Toronto, Rotman School of Management

• Danqi Hu, Northwestern University

• Ole-Kristian Hope, University of Toronto - Rotman School of Management