Audit Market Structure, Auditor Industry Specialization, And Price Competition

A full analysis of the audit market would comprise an assessment of the following features as a minimum: market structure, conduct of firms, and market performance. This is in line with the traditional structure–conduct–performance (SCP) framework for assessing markets, as developed in the industrial organization literature. Following this framework, we first investigate the trends of industry-specific auditor concentration and industry specialization in China's A-share market from 2002 to 2005. Next, we are interested in ascertaining the factors affecting the level of auditor concentration and industry specialization. Finally,we estimate a regression with the audit fee as the dependent variable regressed against industry specialization controlling for certain market structure. The key findings of the research are summarized below:First, there is no significant change in industry-specific market concentration for audit service in China's A-share market. The audit market itself is at the ongoing transition stage towards a loose oligopoly structure. Acting as market leaders, PwC and some biggest national audit firms demonstrate market power in quite a few industries. However, current market participants are still competing fiercely in spite of the high barriers to entry. Such competition counteracts the forming of the loose oligopoly structure. Furthermore, the level of auditor concentration is found to be influenced by the underlying economic characteristics of the buyer market, that means anti-competitive behavior of audit firms as an explanation for (high) auditor concentration becomes less plausible and justifies the acceleration of a more concentrated audit market structure in China.Second, there are indeed some audit firms acted as industry experts in China's A-share audit market, including Big 4, some national big firms and a small proportion of local firms. From 2002 to 2005, the Big 4 experts'industry market share is decreasing while the Big national 3 experts'market share is increasing. Further analysis shows that auditor's industry portfolio share is positively related to their industry market share which indicates that the more a firm invests in certain industry, the higher industry market share it would win. What is more, there is a unique reason for the formation of industry experts in China's audit market: some firms are in the same region with quite a few listed companies they audit, while the concentrated regional distribution of industries improves these auditors industry market shares in certain industries. As a result, if these firms could restructure along industry lines by trans-regional mergers, strain on regional"bottlenecks"is hoped to be lifted significantly.Finally, we study the relation between auditor industry specialization and audit pricing in China's A-share audit market by dividing the market into two segments: the large client segment and the small client segment. Simunic(1980)'s framework for studying audit pricing is applied as the basic model. According to our results, China's A-share market is a competitive structure as a whole. Different audit experts take on different pricing behaviors. For example, systematically higher prices charged by Big 4 would be consistent with their product differentiation throughout the market, while the Big Natioanal 3 and the other local experts are observed to provide low price to the large clients and the smallest clients respectively, which is characterized as diseconomies of scale to non-expert national firms. All of these results support that expanding the size of audit firm by restructuring along industry lines would make a difference between audit products. Moreover, superior operating efficiency provided by scale economies would also increase social welfare if it is realized.The main academic contributions of this study are as follows: (1) we describe China's A-share audit market from an industry view for the first time. We use an organizing framework from structural economics to characterize the market for audit services and to discuss the importance of audit firm industry specialization within the market; (2) We first study the factors affecting the level of auditor concentration and industry specialization; (3) The relationship between industry specialization and one of the most important market performances---audit fee is also explored for the first time controlling for certain market structure. Based on this, suggestions about the future development of national audit firms are put forward. As a whole, this study is an extension of prior works on audit market structure, conduct and performance.