Audit Pricing Structures and Their Relationship with Audit Effort Levels

Abstract

This study investigates the complex relationship between audit pricing structures
and the actual effort levels exerted by audit firms, challenging the traditional assumption that higher fees necessarily correlate with greater audit effort. We introduce a
novel methodological framework that combines econometric analysis with behavioral
audit simulations to disentangle the components of audit pricing—risk premiums, effort compensation, and client-specific premiums—from observable effort metrics. Unlike prior research that relies on fee data as a proxy for effort, we develop and validate
a multi-dimensional effort measurement instrument capturing planning hours, testing
intensity, review layers, and professional skepticism application. Our analysis of a
unique dataset spanning 450 audit engagements from 1998 to 2004 reveals three distinct pricing-effort relationships: (1) a positive but diminishing correlation in high-risk
engagements where effort responds to risk-based pricing, (2) a neutral relationship
in moderate-risk engagements where standardized pricing dominates, and (3) a negative relationship in low-risk, recurring engagements where fee stickiness coexists with
effort reduction. We further identify a previously undocumented ’effort elasticity’ phenomenon, where audit effort demonstrates varying sensitivity to fee changes depending
on client tenure, auditor size, and regulatory environment. The findings challenge conventional audit pricing models and provide new insights for regulators concerned with
audit quality indicators, audit firms designing compensation structures, and clients
negotiating audit engagements. This research contributes to the audit literature by
providing a more nuanced understanding of how pricing mechanisms actually influence
auditor behavior, moving beyond simple input-output models to recognize the complex
behavioral and economic interdependencies in audit production.