| This study examines whether the credence attribute of auditing impacts the audit profitability and the audit production process. The credence attribute of auditing refers to the client's uncertainty about the audit effort needed (ex-ante uncertainty) and the audit effort provided by the auditor (ex-post uncertainty). That is, the auditor as both the expert, the party with the audit expertise who advises the client about the level of assurance needed, and the provider (seller) of the service possesses an information advantage about the production of the audit relative to the client and may find it beneficial to engage in strategic behavior and extract rents. This issue is important because strategic actions may result in adjustments to the audit production process that may undermine audit quality and efficiency.;Initially, this study argues that private information gained through an auditor's repeated interaction with the client, enhances the auditor's incentives to extract rents. However, clients' switching costs mitigate the auditor's incentives over time. As a result, it is predicted that rents initially rise with tenure, but eventually decline as switching auditors becomes less costly for the client. Moreover, clients' own knowledge about the audit process may limit rents. Using proprietary audit engagement data from one of the international auditing firms, the results suggest that rents are highest for mid-tenure clients relative to the short and the long-tenured ones. Further, rents are lower for clients with superior knowledge about the audit process.;Second, this study explores the factors associated with inefficient audits. Using the theory of credence goods as the basis, the study finds that inefficient audits are less likely to occur when competition is high and when clients possess superior knowledge about the audit process, but are more likely to occur in clients that are costly to audit. Moreover, inefficient audits are positively related to the auditor's private information about the client.;The purpose of this study is to understand how audits are conducted by using the theory of credence goods as the basis for explaining auditors' incentives to act strategically. The results presented are consistent with audits being credence goods. |
