Audit firm merger and the strategic response by large audit firms

Motivated by the debate on the potential costs and benefits of having a highly concentrated audit industry dominated by a few Big audit firms (e.g. European Commission, 2009, 2010; US Government Accountability Office (GAO), 2003, 2008; UK House of Lords, 2010, 2011), a growing body of literature examines the consequences of audit firm mergers on audit fees and audit quality (e.g. Choi, Kim, & Raman, 2017; Gong, Li, Lin, & Wu, 2016; Jiang, Wang, & Wang, 2018; Wang, Liu, & Chang, 2011). More recently, in 2019, reports published by the Competition and Markets Authority (CMA) and House of Commons in the UK propose several courses of actions aimed at reforming the audit market and addressing the concerns of high Big 4 concentration, based on the premise that an increase in auditor choice, particularly for large, listed clients, can improve audit quality and resilience in the audit industry (CMA, 2019; U.K. House of Commons, 2019).1 Despite these concerns, existing literature on audit firm mergers generally suggests that audit quality improves after audit We examine the impact of a change in the audit industry structure in China as a result of two recent mergers involving large non-Big 4 audit firms. The 'New Big' audit firms, Ruihua and BDO Lixin, became the third and fourth largest audit firms in China following audit firm mergers, outranking both EY and KPMG in terms of total audit revenues in 2013. We find a significant audit fee and audit quality increase for the New Big audit firms relative to the Big 4 audit firms following the mergers. While this finding could be interpreted as an increase in quality as a result of audit firm consolidation, we find that this net effect is due to a decrease in audit fees and audit quality for the Big 4 following the mergers, rather than an increase in audit fees and audit quality by the New Big audit firms. We discuss the implications of our findings for various regulators. (c) 2020 British Accounting Association. Published by Elsevier Ltd. All rights reserved.