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    City-Level Auditor Industry Specialization, Economies of...
    research summary posted February 17, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    City-Level Auditor Industry Specialization, Economies of Scale, and Audit Pricing
    Practical Implications:

    The consolidation of audit firms from the Big 6 to the Big 5 in 1998, and then to the Big 4 in 2002, has raised concerns about the lack of competition in the large-client market (GAO 2003). However, while it is possible that the consolidation has reduced competition and increased prices, it could also have created efficiencies leading to reduced prices. This study shows that there is some merit in the "efficiency" argument that larger firms pass on an economies-of-scale discount to their clients. The finding provides some support for the GAO’s (2008) observation that there is little evidence of Big N oligopolistic pricing.

    For more information on this study, please contact Jagan Krishnan.


    Fung, Simon Y.K., Ferdinand A. Gul, and Jagan Krishnan. 2012. City-Level Auditor Industry Specialization, Economies of Scale, and Audit Pricing. The Accounting Review 87 (4): 1281-1307.

    industry specialization; scale economies; audit pricing; client bargaining power
    Purpose of the Study:

    Increasing auditor size leads to two outcomes, which include industry specialization due to the expertise developed from expanding within industries, and economies of scale arising from spreading audit investment costs over a large client base. Academic research has examined the effects of industry specialization and, to a much lesser extent, the effects of scale economies, on audit pricing. The authors find that while the national operations of the Big N auditors are evenly divided, their scale of operations are significantly different at the city level. The purpose of this study is to examine whether (and in what settings) the benefits of scale economies at the city level are passed on to clients, particularly in light of concerns that the Big N audit firms dominate the audit market. Evidence on the effects of scale economies on the fees charged to audit clients is therefore of interest to regulators, auditors, and market participants.

    Design/Method/ Approach:

    The authors extract information of Big N auditors as well as their publicly listed audit clients in the U.S. for the period 2000–2007. Observations with missing information, those in the financial sector (which is regulated very differently), and foreign firms are excluded from the sample. The test sample includes 17,207 client-year observations across 54 two-digit SIC industries. Multivariate regressions are used to conduct statistical inferences.

    • There are significant variations in the city-industry scale in the U.S. Big N audit market.
    • Industry specialist auditors at the city-level earn significant premiums (14.8 percent, or $226,000, on average) compared to non-specialist auditors; but audit fees decrease by 1.7 percent (or $25,900) for a one-decile increase in city-industry scale.
    • The effects of industry specialization and economies of scale on audit pricing are highly interactive. The negative effect of city-industry scale on audit fees applies only to industry specialist auditors, and the audit fee premium for industry specialization is smaller for auditors with a larger city-industry scale.
    • The industry specialization premiums are higher after SOX, although scale discounts are slightly smaller. However, the aforementioned interactive effects hold in both periods.
    • Client bargaining power exerts a moderating effect on both the specialization premium and the scale discount. Both specialist and non-specialist auditors pass on some scale discounts to clients with a high degree of bargaining power. However, only specialist auditors pass on scale discounts to clients with a relatively low degree of bargaining power. 
    Client Acceptance and Continuance, Engagement Management
    Audit Fee Decisions, Audit Fees & Fee Negotiations