Academic journal article Auditing: A Journal of Practice & Theory

Auditor Industry Specialization, Client Bargaining Power, and Audit Pricing

Academic journal article Auditing: A Journal of Practice & Theory

Auditor Industry Specialization, Client Bargaining Power, and Audit Pricing

Article excerpt


The purpose of this study is to examine audit pricing by Big 6 auditors, and the joint effects of industry specialization and client bargaining power on audit fees. Drawing on Porter's (1985) analysis of corporate strategy, auditor industry specialization is viewed as a differentiation strategy whose purpose is to provide auditors with a sustainable competitive advantage over nonspecialist auditors. Porter (1985, 14) explains differentiation as follows:

   In a differentiation strategy, a firm seeks to be unique along some
   dimensions that are widely valued by buyers. It seeks one or more
   attributes that many buyers in the industry perceive as important,
   and uniquely positions itself to meet those needs. It is rewarded
   for its uniqueness with a premium price.

While differentiators can potentially charge a premium if buyers value their services, the ability to do so depends on the bargaining power of clients (Porter 1985, 9). Prior research on auditor industry specialization has ignored the role of bargaining power in the pricing process and simply assumed that industry specialists have the ability to set higher prices.

There has been relatively little research on industry specialization and audit fees. There are two published studies that report an industry specialization premium: Craswell et al. (1995), who use Australian data from 1987, and DeFond et al. (2000), who use 1992 data from Hong Kong. There are also two published U.S. studies, both of which fail to find a premium for industry specialization: Palmrose (1986), who uses a sample of utilities, and Pearson and Trompeter (1994), who use a sample of insurance companies. More recently, Ferguson and Stokes (2002), who use Australian data from the 1990s, do not find strong support for industry-specialist premiums. Conversely, Ferguson et al. (2003) re-examine the same 1998 data as that of Ferguson and Stokes (2002) and do find evidence of industry-specialist premiums when city-level measures of specialization are considered. The U.S. studies are narrowly focused on two regulated industries, whereas Craswell et al. (1995), DeFond et al. (2000), Ferguson and Stokes (2002), and Ferguson et al. (2003) test a broader cross-section of industries. However, the Australian and Hong Kong audit markets are much smaller than the U.S. market, which makes the notion of industry specialization (whether measured on a national or city level) more problematic given the relatively small industry clienteles in these countries. In addition, three of these six studies, including both U.S. studies, use data from the mid-1980s and market conditions appear to have changed considerably since that time. (1) For all of these reasons, the prior findings in these studies may not generalize to the current U.S. audit market.

Our empirical tests use more recent U.S. data, and the results are consistent with predictions from the corporate strategy literature. Using a sample of 651 publicly listed companies audited by Big 6 auditors, we find that fees are higher for Big 6 industry specialists. However, these results only hold for the lower half of company size in the study (assets < $123 million). In contrast, for larger-sized companies, we find no evidence of a fee premium for auditor industry specialization, and evidence that audit fees actually decrease as a company's size increases relative to their auditor's clientele in that particular industry. Together these results are consistent with a differentiation premium for industry specialization, but only for smaller clients having low bargaining power with their auditors. When bargaining power is greater, there is no specialization premium and evidence of a fee discount.

The remainder of the study is organized as follows. First we use Porter's (1985) corporate strategy framework to analyze industry specialization and audit pricing. Next the empirical design and sample is introduced followed by empirical results and sensitivity analyses. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed


An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.