Additional Evidence on the Economics of Attest: Extending Results from the Audit Market to the Market for Compilations and Reviews.

Abstract This study extends some basic results from the economics of auditing literature to the purchase of compilations and reviews. For example, previous work involving only audits has shown that larger accounting firms command a fee premium and that, on balance, higher fees result when accounting firms perform consulting services as well as the audit. With regard to the demand for audit work, prior research has shown, for example, that the larger the auditee, the greater the demand for a large audit firm. This study investigates the market for compilations and reviews by developing two models, a fee model and a demand model. Two samples from privately held manufacturing firms with fewer than 100 employees were used: a 1983 sample of 436 firms for the fee model, and a 1988 sample of 196 firms for the demand model. With respect to fees, the evidence suggests that national accounting firms earn premiums, not only for audits, but also for compilation and review services. Also, results show that fees for compilations increase when the accounting firm also provides management advisory services. Compilation fees decrease when the accounting firm also provides bookkeeping services to the client. However, there is no evidence that audit or review fees are affected by the provision of non-attest services. Not surprisingly, fees vary sharply according to the type of engagement, with audits commanding the highest fees, followed by reviews, and then compilations. This variation in fees is consistent with the premise that the level of assurance depends on the type of attest service. With respect to the demand for attest services, the data suggest that the agency costs faced by the firm are important determinants of the selected level of assurance. Specifically, the demanded level of assurance increases with client firm size (a proxy for manager-employee agency costs) and also with the existence of debt covenants based on accounting numbers (a proxy for owner-creditor agency costs). The demanded level of assurance decreases with the percentage of the firm's shares held by officers and directors (a proxy for owner-manager agency costs).