The Effect of Potential Entrants on Audit Market Competition

ABSTRACT Regulators and academics have long explored the implications of audit market competition on audit pricing and quality, primarily focusing on large audit firms. Despite a presumption of competition among smaller accounting firms, little evidence exists regarding whether and how competition influences audit pricing and quality among them. Additionally, within this market, prior research typically considers competition only from audit offices already serving public-company clients. This study uses a unique database with office-level data for all audit firms in the U.S., regardless of whether they audit public companies, to examine the role of potential entrants. Examining both incumbent threats (offices without public clients but affiliated with a firm serving public clients) and external threats (offices of PCAOB-registered audit firms with no public clients) as sources of competition, the findings suggest that potential entrants are associated with improvements in audit quality and reductions in audit fees for clients of triennially inspected auditors. Data Availability: Data are available from the sources identified in the paper. JEL Classifications: M41; M42; D40; R32.