Competitive Strategies for Small Audit Firms

SynopsisThe research problemWe examine whether small audit firms adopt niche strategies to compete in the public company audit market. To that end, we focus on auditors servicing clients from one industry only (which we label as a nationwide single-industry focus) and test its association with audit quality and pricing.MotivationPrior research on auditor competition has mainly focused on the large (mainly Big Four) audit firms. While large and small audit firm markets are two distinct markets, little is known about competitive strategies of small audit firms in the public company audit market.The test hypothesesOur first hypothesis is that small audit firms adopting a single-industry focused strategy supply higher audit quality compared with audit firms that do not adopt a single-industry focused strategy or a simple industry specialization strategy, ceteris paribus. Our second hypothesis is that small audit firms adopting a single-industry focused strategy engage in discount pricing compared with audit firms that do not adopt a single-industry focused strategy or a simple industry specialization strategy, ceteris paribus.Target populationThe U.S. commercial banking sector covering the period 2004–2020.Adopted methodologyMultivariate analyses adopting linear and probit models.AnalysesTo test our first hypothesis, we run a bank audit quality model using loan loss provisions as the dependent variable for our main analyses. Subsequent analyses adopt restatement, going concern, and internal control weaknesses models. To test our second hypothesis, we rely on a bank audit fee model. All models include relevant controls established in previous research and those for self-selection.FindingsThe evidence suggests that small audit firms adopting a nationwide single-industry focus are able to provide higher audit quality (compared with other rivals, even industry specialists) while at the same time charging lower audit fees implying cost efficiencies that are passed on to the client due to their focused expertise.