The Effects of Demand Uncertainty on the Production of Audit Services

Economic theory suggests that demand uncertainty should influence producer behavior. In this study, we empirically examine the impact that demand uncertainty has on the production of audit services. Auditors must make resource allocation decisions in advance of exact demand being known. Because a large portion of an auditor’s capacity-related commitments are fixed and therefore difficult to adjust in the short run, any variability in client demand outcomes likely imposes significant costs on auditors. Consistent with auditors being compensated for these costs, our results indicate that both audit price and audit production delay are positively related to a client’s uncertainty in demand for audit services. We also find that price and production delay act as substitute mechanisms used by the auditor to alleviate the costs imposed by demand uncertainty. Our study contributes to the growing literature on the underlying economics of the audit market and answers recent calls for analysis of demand-side factors that influence the audit industry.