The effect of tenure on auditor realization rates

Abstract

Purpose – The purpose of this study is to test whether the realization rate on audit engagements increases with auditor tenure in competitive markets, suggesting the presence of initial audit lowballing. Design/methodology/approach – Using regression analysis, we test this hypothesis with fee- and cost-related data from a sample of local governments audited by a single audit firm. Based on representations of the firm, we classify the audit market for the 127 cities, counties and school districts in our sample as competitive and the audit market for the 93 special district audits as non-competitive. Findings – As hypothesized, we find that in the competitive market, the realization rate on audit engagements increases with auditor tenure but does not do so in the non-competitive audit market. Research limitations/implications – We cannot identify the specific engagements which were subject to a competitive bidding process, so we rely on the auditor’s representation of competitiveness by entity type. Originality/value – To our knowledge, the central prediction of audit pricing models that the auditor’s realization rate increases with auditor tenure has not been tested in real audit markets because proprietary cost data are rarely available. Testing this prediction is the primary contribution of this paper.