Fee Competition Among Big 4 Auditors and Audit Quality
Review of Quantitative Finance and Accounting (February 2019), 52(2): 403-438.
Posted: 9 Feb 2019
Date Written: February 2019
Both the GAO (2003, 2008) and the US Treasury (2008) have implied that the Big 4 dominated US audit market lacks competition. More recently, the PCAOB has expressed a somewhat different concern, i.e., that because audit committees may be primarily interested in negotiating a lower audit fee (rather than championing higher audit quality) for their clients, fee competition in the US audit market could pressure the incumbent auditor to compromise on audit quality (Doty 2011). We utilize the notion of counterfactual fees chargeable by auditors to assess fee competition and investigate competing views on the relation between fee competition among Big 4 auditors and audit quality in US local audit markets. To operationalize fee competition at the client-level in the context of each local audit market, we compute a separate counterfactual audit fee that would be charged by every other Big 4 auditor for that particular engagement and use the minima of the counterfactuals. We validate our audit fee competition metric by showing a positive relation with the incumbent auditor’s switching risk. Collectively, our findings suggest that fee competition is useful as a mechanism for improving audit quality in the highly concentrated US audit market, albeit only in local audit markets where the incumbent auditor has below-median market power and only for higher quality clients. Overall, our findings speak to the interplay between fee competition and auditor incentives and is are of potential interest to regulators such as the PCAOB concerned about competition in US audit markets.
Keywords: Big 4 Firms, Audit Fee Competition, Audit Quality, PCAOB
JEL Classification: M41, M42
Suggested Citation: Suggested Citation