The Evolution of Audit Market Structure and the Emergence of the Big 4: Evidence from Australia

Abstract

We use evidence from a large panel of Australian audit market data to shed light on how changes in the demand for audits affects costs and market structure in the audit industry. The panel spans nearly 50 years, and begins before the emergence of the Big 4 in Australia. Over this period, the size distribution of companies becomes increasingly bifurcated, with the market increasingly dominated by a small number of large, complex entities. We argue that this change caused a structural shift in the demand for audit services and led to the emergence of the Big 4. Specifically, we argue that auditing these increasingly large and complex entities necessitated investments by their auditors in endogenous sunk costs (Sutton, 1991), which led to the emergence of a small set of increasingly dominant audit firms (the Big 4). We provide evidence consistent with these ideas. The results have implications for the current regulatory debate on audit market concentration and the role of the Big 4.