Contracting Frictions, Regulation, and the Structure of CPA Firms

Abstract

The prominence of management consulting services in the largest CPA firms leaves little doubt that there are economies of scope between auditing and at least some types of consulting. The source of these economies of scope has been conjectured to be the result of information produced as a by-product of performing audit work (e.g., Simunic [1984]). This information may be about the benefits to a client from a certain type of consulting project, or it may be about how best to produce desired consulting services and thereby reduce the cost of supplying these services. The purpose of this paper is to explore theoretically another potential source of economies of scope: contracting frictions. The particular contracting frictions we study arise from the CPA firm's private information about the costs of performing auditing and consulting for a particular client. We show such private information may give rise to economies of scope, in the sense that the client is better off purchasing auditing and consulting from the same CPA firm as opposed to separate sourcing of the two