Product Market Competition and Audit Fees

Abstract

Existing theories posit two contradictory predictions on the relation between product market competition and audit fees. On the one hand, firms in a competitive market are expected to face higher liquidity risk, liquidation risk, and distress risk, thus increasing auditors’ assessment of client’s business risk. So audit fees are expected to increase with industry competitiveness. On the other hand, product market competition mitigates agency problems between shareholders and managers and increases the accuracy of financial reporting, thus decreasing auditors’ assessment of client’s audit risk and necessary audit efforts. So auditors tend to charge lower fees on firms in a more competitive industry. This study empirically tests the relation between product market competition and audit fees and finds that auditors charge higher on firms in a more competitive industry. This study also shows that within an industry, auditors charge lower fees on firms with greater market power.