Competition in Auditing Revisited: Theory and Evidence Re-examined

Abstract

Observers report that, of late, US audit clients have come to view audits as commodities rather than as quality-differentiated products (Elliott 1994, AICPA 1995a), and to view audit providers as being undifferentiated except on price (Stevens, 1991). How might such a shift in the basis of competition affect the structure of the audit market? To examine this issue, we construct a model of pure price competition and predict audit industry structure for a sample of 5320 publicly traded US industrial companies and the 306 US audit firms that audit them. We find that under a variety of market clearing rules, price competition among auditors leaves current industry structure essentially unaltered. We also find that given current industry configuration, pure price competition generates industry structures similar to what we observe in our sample. Our results show that product differentiation is not necessary either to generate or to sustain observed industry structure.