Measuring Audit Market Competition with the Number of Auditors: A Re-examination of the Effect of Competition on Audit Quality

Abstract

This study examines whether and how auditor turnover, audit fees, and audit quality are associated with the residual number of audit service providers (i.e., audit offices) located in the local city, i.e., the deviation from the normal level predicted by the characteristics of the local city. We first find that the frequency of auditor turnover increases with the residual number of auditors, suggesting that competition among auditors in the local audit market increases with the residual number of auditors. Second, both audit fees and quality decrease with the residual number of auditors. Third, the aforementioned effects are mainly driven by the residual number of non-Big 4 auditors rather than by that of Big 4 auditors. Fourth, such effects are evident only in the market segment comprising small and medium-sized clients, but not in the segment of large clients, who are likely to demand audits exclusively from Big 4 auditors. These findings provide valuable insights into the effect of local audit market structure on audit contracting and audit outcome.