On the economics of product differentiation in Auditing;

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On the Economics of Product Differentiation in Auditing*
Dan A. Simunic Michael Stein
University of British Columbia
I. Introduction
Corporate financial statement audits have traditionally been viewed as homogeneous across auditors. For example, the Commission on Auditors' Responsibilities ("Cohen Commission") in its Report [1978, p. 111] stated that:
When a product or service offered by different suppliers differs significantly to the user, or appears to differ significantly, it is easier for one of its producers to maintain a higher, noncompetitive price. Public accounting firms go to considerable length to develop superior services for their clients, but there is little effective product differentiation from the viewpoint of the present buyer of the service (emphasis added), that is, management of the corporation.
In support of this view, it is usual to assert that the identity of the firm which performs an audit is irrelevant since every examination must conform to generally accepted auditing standards (GAAS) and all firm partners must be fully professionally qualified. Thus users of financial statements have no reason (nor basis) to distinguish among auditing firms.
At the same time, however, it has also been recognized that a company which may have a perfectly satisfactory relationship with a local accounting firm will often change auditors to a well-known national firm when that company first sells securities to the public. It is usually alleged that such "displacement" occurs as a result of pressure from underwriters (see, for example, Wall Street Journal, July 18, 1983, "Small CPA Concern Sues an Underwriter Over Loss of Client") or because of other unwarranted "biases." For example, Arnett and Danos [1979] use the term "perceptual barriers to viability" to describe these "biases." Under the assumption that the services of auditing firms are homogeneous, it follows that professional accounting
*The research study, upon which this paper is based, was funded by a grant from the Canadian Certified General Accountants' Research Foundation (Vancouver, B.C.), whose support we gratefully acknowledge. Also, we have benefited from the comments of participants in the accounting workshops at the University of Alberta, University of British Columbia, Ohio State University, and Washington University (St. Louis) on earlier versions of the paper.
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