Price Competition Within the Large Audit Firm Oligopoly : A Panel Data Analysis of Initial Engagements

We study audit pricing and quality for companies that switch from one BigN firm to another. In addition to present day policy interest in the competitiveness and quality of the large audit firm / public company market, and longstanding policy interest in the pricing and quality of initial audit engagements, our motivation stems from contrary predictions in the theoretical literature and mixed evidence in the empirical literature. We collect a series of balanced panel datasets of BigN auditees from the first eight years of disclosure of U.S. audit fees and estimate a series of fixed-effect regressions. We report evidence of economically significant discounting of initial audits for companies that switch among BigN firms but that audit fees then increase substantially for the second-year audit. To the extent restatements and going-concern opinions are adequate proxies, our results do not suggest differential audit quality for companies that pay lower audit fees when switching among BigN firms. Overall, our paper is the first to study BigN switching with a comprehensive sample that spans several years using a panel data design, to document economically significant amounts of initial audit fee discounts (that vary over time in a manner consistent with recent audit market changes and primarily vanish the very next year) and to examine the association between initial audit fee discounts and multiple proxies for audit quality