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The Effects of Business Risk on Audit Pricing

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  • John Morgan

    (Princeton University)

  • Phillip Stocken

    (University of Pennsylvania)

Abstract

This paper examines the pricing of business risk by homogeneous auditors in a two period model. Incumbent auditors learn the client's business risk type during the course of the engagement. They subsequently compete in prices with prospective auditors. In such an environment, we show that equilibrium audit fees do not fully reflect the cost of business risk. Moreover, there exists differential auditor turnover between high and low risk firms; cross-subsidization of the audit fees of high risk firms by low risk firms; and low-balling by auditors.

Suggested Citation

  • John Morgan & Phillip Stocken, 1998. "The Effects of Business Risk on Audit Pricing," Review of Accounting Studies, Springer, vol. 3(4), pages 365-385, December.
    • Handle: RePEc:spr:reaccs:v:3:y:1998:i:4:d:10.1023_a:1009687101871
    DOI: 10.1023/A:1009687101871
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    References listed on IDEAS

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    1. Fudenberg, Drew & Tirole, Jean, 1991. "Perfect Bayesian equilibrium and sequential equilibrium," Journal of Economic Theory, Elsevier, vol. 53(2), pages 236-260, April.
    2. Dye, Ronald A., 1995. "Incorporation and the audit market," Journal of Accounting and Economics, Elsevier, vol. 19(1), pages 75-114, February.
    3. Dye, Ronald A., 1991. "Informationally motivated auditor replacement," Journal of Accounting and Economics, Elsevier, vol. 14(4), pages 347-374, December.
    4. Martin J. Osborne & Ariel Rubinstein, 1994. "A Course in Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262650401, December.
    5. Simunic, Da, 1980. "The Pricing Of Audit Services - Theory And Evidence," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 18(1), pages 161-190.
    6. DeAngelo, Linda Elizabeth, 1981. "Auditor size and audit quality," Journal of Accounting and Economics, Elsevier, vol. 3(3), pages 183-199, December.
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