An experimental market analysis of auditor work-level reduction decisions

In this paper, we use an experimental market to test the link between competitive fee pressure and its alleged downstream consequences: time pressure and audit quality reduction. To induce fee pressure, transaction (auditor switching) costs, which have been found to be associated with fee lowballing in prior research, are manipulated in a competitive bidding environment. Our results show that (after controlling for subject skill level) the presence of transactions costs induces lower audit fees in first year engagements which result in significantly lower time budget levels selected and then, in turn, significantly higher levels of audit work-level reductions. Also, confirming prior survey results on the causes of audit quality reduction acts, we find that subjects encountering lower perceived misstatement rates select significantly lower time budgets and then, in turn, evidence significantly higher audit work-level reductions. These findings lend support to regulators' assertions about the link between fee competition and the potential for reductions in audit quality.