Audit Market Concentration, Auditor Switching and Audit Fee Pricing: An Investigation of the UK Private Company Audit Market, 2005-2012

Statutory audit markets across the EU have recently been reformed, with new Regulation on the Statutory Audits of Public Interest Entities coming into force in June 2016. The Regulation imposes stricter requirements on the audits of Public Interest Entities, as originally defined in the Statutory Audit Directive 2006, with the option for Member States to designate additional entities as public interest. Thus, the exact definition of a Public Interest Entity applied varies across Member States. In the UK the definition has not been widely extended and includes listed firms, credit institutions, and insurance undertakings. Private firms in the UK are therefore currently exempt from the more stringent audit regulations. However, even based on the limited, and often mixed, evidence for the private company audit market, the decision to preclude most private companies from the definition of a Public Interest Entity, effectively excluding them from the new audit reforms, may not be appropriate. This thesis, therefore, undertakes a comprehensive analysis of the UK audit market for private companies, in addition to examining the auditing choices of private companies and the economic consequences of these choices. The UK is specifically examined because it is one of a number of countries that have chosen not to extend the scope of the definition of a Public Interest Entity beyond the one set at the EU level. The findings of this research show that, similar to the audit market for listed firms, the private company audit market in the UK is segmented with Big Four dominance among the largest firms and relatively low levels of auditor switching. As a result of this audit environment, private companies that do switch auditor are found to experience economic consequences in terms of a reduction in their credit ratings. Particularly when the reasons for a switch are unknown to investors. In addition, the thesis provides evidence to suggest that following an auditor switch, firms receive both physical and implicit discounts on their audit fees, with price recovery of these discounts over the following three years. Suggesting that low-balling is also present in this audit market, which in turn raises concerns regarding competitive pricing and levels of auditor independence. In sum, the results of the thesis provide strong support that the definition and scope of a Public Interest Entity needs revisiting both within the UK and across all EU Member States. Moreover, it reinforces the idea of extending some of the more stringent audit requirements introduced by the EU Regulation on the Statutory Audits of Public Interest Entities, to ensure that economically important private firms have sufficient oversight.