Auditor Size and Audit Quality Revisited : The Importance of Audit Technology

We revisit the notion of audit quality and investigate how audit quality is related to auditor size and the structure of the auditing industry. We discuss a model of audit firm competition where both audit quality and audit firm size are endogenous. Based on this model, we predict how certain market characteristics, namely market size and investor protection regime, affect the structure of the auditing industry and differences between Big 4 and non-Big 4 audit quality and fees. In the model, audit technology plays a central role in determining the level of audit quality and fees as Big 4 auditors compete on both quality and price through fixed investments in technology, the level of which is increasing in both market size and the level of investor protection. The model offers a coherent explanation for the documented ‘Big 4/non-Big 4 dichotomy' and dual structure of the industry.Our analysis has both testable empirical implications and policy implications. It provides insights on how audit firms compete and how the industry evolves, and suggests that despite high levels of market concentration, the market for audit services remains competitive and innovative, consistent with empirical evidence