This study examines whether recent mergers between small and midsize accounting firms influence competition by increasing the number of firms that can compete with larger rivals in the U.S. public company audit market. I find that in-market mergers generate efficiencies that are reflected in a post-merger reduction in audit hours but not in reduced audit quality. For both in-market and out-of-market mergers, clients switching to post-merger firms are more likely to be accelerated filers and are significantly larger in terms of several proxies for size and complexity. Lastly, I find that an increase in market-level merger activity is associated with lower profitability of Big 4 firms operating in the same market but only in the smaller client segment. These findings suggest that recent mergers have actually increased competition in some segments of the audit market despite already high concentration and concerns about a lack of sufficient competition.

ABSTRACT This study investigates the relation between audit competition, audit quality, and auditor labor hours. Using proprietary data on auditor realization rates, we construct new measures of competition based on theory predicting that abnormal profits will quickly disappear when competition is high but persist over multiple periods when competition is low. We find consistent evidence of persistent abnormal profits among U.S. Big 4 engagements and that individual offices earn persistent abnormal returns, suggesting that the market is not perfectly competitive. Examining the consequences of lower competition, we find that profit persistence is negatively related to audit hours and positively related to audit quality. Although we are cautious about inferring causality, our findings suggest that lower competition is associated with more efficient and effective audits.

ABSTRACT Macroeconomic forces are challenging the ability of audit firms to sustain engagement profitability. Although one available strategy for multinational clients is to employ non-U.S. firms as component auditors (CAs), the impacts of this choice are unclear. We investigate the influence of CAs on engagement economics in Big 6 audits from 2012 to 2022, a period of increasing non-U.S. labor use. Results show that global hours increase with CA participation, suggesting that additional CA labor is needed to substitute for each U.S. hour. Global billing rates decline, implying that principal auditors share savings from lower cost labor with clients. However, U.S. lead team realizations rise with increasing substitution of non-U.S. labor, incentivizing more extensive CA use. Further analysis shows that these impacts are concentrated in engagements with high CA participation in countries with low wages and low English proficiency. Audit quality is not reduced by greater substitution of non-U.S. labor. JEL Classifications: M40; M42; M48; F66.