We develop a measure to capture an audit firm's competitive position in a local audit market based on the transaction costs of changing audit firms included in DeAngelo's (1981) multi-period audit pricing model. Our competition measure reflects the size difference between the largest audit firm in a market specified by client industry at the city level and the other audit firms operating in that market. We find that audit fees of a client decrease as this size difference increases. This result suggests that smaller audit firms charge lower audit fees because of their competitive disadvantage to the local largest firm.

We analyze whether and how the perceived federal‐level legal liability linked to federal judge ideology is associated with the likelihood of firms receiving going‐concern modified audit opinions and analyze the differential effects on Big 4 and non–Big 4 auditors. We find that Big 4 and non–Big 4 auditors converge in their going‐concern reporting decisions in circuits with more liberal judges. This convergence is caused by the greater effect of judge ideology on non–Big 4 auditors. Furthermore, we empirically examine the association between federal judge ideology and actual lawsuits against auditors and find that judge ideology has a greater impact on lawsuit likelihood for non–Big 4 auditors for the restating companies. When auditors are sued, both the payout likelihood and amount are greater in circuits with more liberal judges, with the effect being more pronounced for non–Big 4 auditors. This study provides evidence on how the perceived exposure to a gross negligence legal standard shapes auditors' going‐concern reporting incentives for the two tiers of auditors in the market. It also adds to the literature on auditor litigation.