A Research Note on the Relationship between Regulation and Audit Firm Size on Audit Fees

This study represents an initial attempt to examine some specific jiictors that might lead to large firms ’ economies of scale. Multiple regression analysis is used to test hypotheses concerning scale op-portunities conferred o r 1 large CPA firms in dealing with regulatory complexity faced by the client. An analysis of interaction between audit firm size arid variables measuring client regulatory complexity shows that audit fees are lower for all firms in regulated industries compared to noitregulated industries-the dtfference being much greater, however, for Big Eight (now Big Six) firms, and audit fees charged by Big Eight firms are rituch lower when the auditor is involved with client security registratiotis. This relationship does tiot hold true for non-Big Eight firms involved with client registration statements. Based on these results, it appears that client regulatory complexity confers greater scale opportunities to larger audit firms compared to smaller ones. Several studies [ 1,2,3] examining auditor concentration in the U.S. audit market have provided evidence that substantial economies of scale exist for the CPA firm in dealing with the regulatory complexity faced by clients. These studies, however, did not directly examine production costs or audit fees. If economies of scale do exist, and assuming that relative production costs are reflected in the external audit fce, then audit fees charged by firms are expected to be lower in a regulated environment compared to a non-regulated one. The present study examines the effect of variables proxying for regulatory aspects of the client on external audit fees. As has been suggested by the Commission on Auditors ’ Responsibilities [4] and Arnett and Danos 151, it can be argued that substantial economies of scale exist for the CPA tirms in dealing with the regulatory complexity faced by clients. For example, to issue an opinion on a client’s 10-K filin