Determinants of the Profitability of Audit Engagements: An Empirical Study
Posted: 31 Oct 2012
Date Written: October 28, 2012
This study reports the results of an investigation into the profitability of audit engagements. The study is motivated by the frequently expressed concern regarding the lack of competitiveness within the audit market, based on trends of increasing concentration of suppliers. Increasing concentration is thought to facilitate collusion and monopoly behavior, allowing firms to raise prices above cost. The current study investigates whether higher market concentration (share) allows firms to earn economic rents. A model for explaining audit engagement profitability is constructed and tested on a sample of 125 audit engagements conducted by a (then) Big 6 audit firm. The results show that local structure has a significant and positive association with audit engagement profitability. We conduct additional tests of the audit production process and find that market concentration does not significantly impact auditor effort. As a result, we provide evidence consistent with either the structuralist or efficiency explanations of the relationship between market concentration (share) and profitability, but that market concentration (share) does not result in lower auditor effort.
Keywords: audit services, audit engagement profitability, audit markets
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