Transaction Costs and Competition among Audit Firms in Local Markets

52 Pages Posted: 13 Jan 2014 Last revised: 6 Jan 2017

See all articles by Ling Chu

Ling Chu

Wilfrid Laurier University

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business

Minlei Ye

University of Toronto

Ping Zhang

University of Toronto - Rotman School of Management

Date Written: January 5, 2017

Abstract

We develop a measure to capture an audit firm’s competitive position in a local audit market based on the transaction costs of changing audit firms included in DeAngelo’s (1981) multi-period audit pricing model. Our competition measure reflects the size difference between the largest audit firm in a market and the other audit firms operating in that market. We find that audit fees of client firm i decrease as this size difference increases. This result suggests that dominant audit firms charge higher audit fees because of their significant local competitive advantage over smaller audit firms. In addition, we show that the boundaries of audit markets are mainly specified by client industry at the city level. However, the size of operations of a dominant audit firm outside such markets can enhance its competitive advantage within a client-industry, city-level market. Our study provides a market-power-based explanation for the excess audit fees earned by the largest audit firm(s) in local audit markets and advances understanding of audit market competition.

Keywords: Audit pricing, competition, transaction costs

JEL Classification: M41, D40

Suggested Citation

Chu, Ling and Simunic, Dan A. and Ye, Minlei and Zhang, Ping, Transaction Costs and Competition among Audit Firms in Local Markets (January 5, 2017). Available at SSRN: https://ssrn.com/abstract=2378039 or http://dx.doi.org/10.2139/ssrn.2378039

Ling Chu

Wilfrid Laurier University ( email )

75 University Ave W
Waterloo, Ontario N2L 3C5
Canada

Dan A. Simunic

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
416-486-5361 (Phone)
416-486-6158 (Fax)

Minlei Ye (Contact Author)

University of Toronto ( email )

Toronto, Ontario M5S 3G8
Canada

Ping Zhang

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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