Demand Uncertainty and the Production of Audit Services
51 Pages Posted: 7 Sep 2019 Last revised: 15 Nov 2022
Date Written: November 8, 2022
Economic theory suggests that demand uncertainty should influence producer behavior. In this study, we empirically examine the impact of demand uncertainty on the production of audit services. Auditors must make resource allocation decisions in advance of exact demand being known, and because a large portion of an auditor’s capacity-related commitments are fixed and therefore difficult to adjust in the short run, uncertainty in client demand outcomes likely imposes costs on auditors. Consistent with auditors being compensated for these costs, our results indicate that both audit price and audit production timing are affected by a client’s uncertainty in demand for audit services. We also find that these compensation mechanisms act as substitutes used by auditors to alleviate the costs imposed by demand uncertainty. Our study contributes to the growing literature on the underlying economics of the audit market and answers recent calls for analysis of demand-side factors that influence the audit industry.
Keywords: producer theory; demand uncertainty; capacity constraints; audit production
JEL Classification: M40, M41, M42
Suggested Citation: Suggested Citation