Expanding Audit Research Using Demand Estimation Techniques

• Applicant: Professor Dr. Christopher Koch
• Subject Area: Accounting and Finance
• Term: since 2018
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 407086517

The audit market regularly attracts the attention of public debate and of policy makers. Recently, the European Union issued an audit directive and regulation with the goal to ensure the functioning of the audit market and to improve audit quality. Currently, the German legislators is drafting new regulation in response to the Wirecard scandal. Some key provisions concern the process of selecting audit firms.Auditor selection has not only recently attracted the attention of regulators but it is also an important topic in audit research. For example, agency theory suggests that hiring a high-quality auditor provides value for companies because it reduces information asymmetries between management and investors. However, prior empirical research in auditing mostly relies on the regression approach. An important limitation of this approach is its neglect of the cost-benefit trade offs in selecting an auditor. As Gerakos and Syverson (2017) point out, demand estimation techniques represent novel promising tools for future research in auditing. Demand estimation techniques such as discrete choice models are used regularly in industrial organization and quantiative marketing. However, auditing research has only just started to apply this technique. Therefore, the goal of this grant proposal is to contribute to auditing research by applying demand estimation techniques. In particular, the project shall provide new evidence on four fundamental issues in auditing. The first project is about the role of information spillovers in auditor selection. Information spillovers occur if the auditor advertently or inadvertently shares information gained from one client with another clients or with the audit teams of other clients. The main contribution will be the consideration of the dynamics of auditor choice using insights from game theory. The second project addresses the role of auditor industry specialization and corporate governance. Specializing in an industry is one important way how audit firms are able to differentiate themselves from competitors. The main contribution will be the consideration of both national and regional industry specialization within the discrete choice framework. Further, interdependencies with corporate governance mechanisms will be considered. The third project is about the quantification of switching costs. Although switching costs are an important cornerstone for economic theories on auditor pricing, auditor independence, and audit quality, evidence on the actual size of switching costs is missing. The goal is to quantify these switching costs and to evaluate its consequences for audit fees and audit quality. The fourth project concerns auditor reputation. Auditor reputation is an important market-based incentive to ensure audit quality. The goal of the project is to identify whether clients are sensitive to changes in auditor reputation for quality and strictness.

• DFG Programme: Research Grants