ABSTRACT
The study of the economic incentives and relations surrounding the independent audit of client financial statements emerged as a topic for academic research about 40 years ago (see Simunic and Stein, 1995). Prior to the mid-1970s, auditing was viewed as a purely practical activity, governed by technical rules largely set by the profession itself. But of course, auditing is a professional business practised by public accounting firms in the wider economy. As such, auditors (audit firms) are subject to economic incentives and the discipline of the markets in which they operate. Moreover, the incentives facing auditors are unusually complex. An independent audit largely benefits both existing and potential shareholders and creditors who do not contract directly with the auditor. Rather, an auditor usually transacts with a legal entity (the company) and interacts extensively with the entity’s management whose assertions in the financial statements are being verified. The terms of the transaction between the auditor and the client – that is, the price, quantity, quality and other features of the service performed – are obviously important, and will be influenced by the market in which the audit firm operates.
