Organizational Form and Audit Pricing

The conventional view in accounting is that diversification increases audit complexity and, in turn, audit fees. Conversely, the coinsurance effect of diversification hypothesis suggests that combining multiple business segments with imperfectly correlated earnings provides a coinsurance effect that could alleviate the adverse impact of several audit fee determinants. Given these opposing views, we examine the impact of organizational form on audit fees and find that diversified firms incur less audit fees than comparable portfolios of stand-alone firms. The negative effect of diversification on audit fees is stronger for Big-N audit firms, consistent with these audit firms benefitting more (suffering less) from the coinsurance (complexity) effect of diversification than non-Big N audit firms. However, the benefits of diversification fade in the presence of financial constraints, consistent with the notion that auditing financially constrained clients that are also diversified entails additional risk. We confirm our results using a battery of sensitivity analyses