Office-Client Balance and Metro Area Audit Market Competition

We propose a new audit supplier competition construct: the Office-Client Balance (OCB), which consists of the relative abundance of suppliers (competing audit offices) and customers (audit clients) in a metropolitan (metro) area. From this construct, we derive a metro-level audit competition proxy reflecting surpluses or shortfalls of total metro audit office numbers relative to the national metro OCB norm: the OCB_TOT. Consistent with the predictions of Porter's Five Forces theory, we find that this OCB competition variable is associated with lower fees, more auditor turnover, and more (less) office exits (entrances) in metro audit markets. These findings validate the OCB competition variable as a proxy for audit market competition. We then employ OCB_TOT to test a hypothesis about the relation between OCB competition and audit quality. Results indicate that greater metro-level competition among auditors (more positive OCB_TOT) is associated with higher audit quality, proxied by fewer instances of financial statement misstatements. Several additional analyses suggest that OCB_TOT is useful in explaining clients' choices of local (versus remote) audit offices and Big 4 (versus non-Big4) offices