Auditor Locality, Audit Quality and Audit Pricing

Abstract

Using a large sample of audit client firms over the 2002-2005 period, this paper investigates whether and how the locality of auditor or the geographic proximity between auditors and clients affects audit quality and audit pricing. We use two measures of abnormal accruals to draw inferences about audit quality, and we differentiate local auditors from non-local auditors based on: (1) whether or not the practicing office of an audit engagement is located in the same metropolitan statistical area where the client is headquartered; and (2) whether or not the actual geographic distance between two cities where the auditor's practicing office and the client's headquarters are located is within 150 miles. Our empirical results reveal the following: First, clients of local auditors report significantly less absolute abnormal accruals and lower income-increasing (positive) abnormal accruals than clients of non-local auditors. This finding is consistent with the view that information advantages associated with local audits help local auditors constrain management's biased earnings reporting. Second, the audit fees paid to local auditors are lower than those paid to non-local auditors, suggesting that cost savings associated with local audits are sufficiently large to dominate potential fee premiums for high-quality local audits. Taken together, our results imply that local audits may enhance audit quality with lower audit fees charged to clients.

Keywords: Auditor locality, Geographic proximity, Audit quality, and Audit pricing

JEL Classification: M42