This study tests whether them is a positive association between a firm's agency costs and its demand for a quality-differentiated audit. Audit firm quality is represented in two ways: a continuous size model in which a direct association is posited between auditor size (measured by clients' sales) and audit quality, and a "brand name" model in which the Big Eight group of auditors is defined as higher quality suppliers. The tests are supportive of the brand name model of audit quality: agency cost proxies are significant as a group, after controlling for client size and growth, only in the brand name model. The results are also supportive (albeit weakly In some Instances) of the following individual agency-related Incentives for higher quality audits: monitoring of Incentive performance contracts, diffusion of ownership, owner-debtholder conflict, and the subsequent Issue of public securities after the auditor change. However, the explanatory power of the models tested is low, after controlling for client size and growth.

The Commission on Auditors' Responsibilities expressed concern for the adverse effect of audit fee price cutting on auditor independence. In the present study, tests were conducted to determine both the presence and magnitude of audit fee price cutting on 1984 audit fees for a sample of 214 firms having changed auditors over the period 1979–1984. A control sample of 226 firms not changing auditors over the same period was used in order to estimate price cutting. Results indicated a significant fee reduction in the initial engagement year that averaged 24 percent of normal fee levels for ongoing engagements, an average fee reduction of 15 percent for each of the next two years, but by the fourth year of the new auditor the fee had increased to normal levels for continuing engagements. The Commission's concern for price cutting's effect on auditor Independence is then reconsidered in the context of recent work on the psychology of sunk costs.