The Role of Financial Institutions in Financial Markets

Journal of Accounting and Economics 35 (2003) 255–281

The public accounting industry production function$
Rajiv D. Banker*, Hsihui Chang, Reba Cunningham
School of Management, The University of Texas at Dallas, Richardson, TX 75083-0666, USA Received 9 December 1999; received in revised form 3 August 2002; accepted 20 January 2003

Abstract A translog function is specified to represent the relation between revenue and human resource inputs in public accounting firms. Estimation of the model using a balanced panel of annual data for 64 large CPA firms for the period 1995–1999 indicates that increasing returns to scale prevail in the public accounting industry, justifying recent merger and acquisition activities among accounting firms. Average marginal revenue product of partners increased monotonically from 1995 to 1998, decreased slightly in 1999, and was about nine times that of other professionals during 1995–1999. The public accounting industry exhibited continuing improvement in productivity over the 5 years. r 2003 Elsevier Science B.V. All rights reserved.
JEL classification: D24; L11 Keywords: Public accounting; Scale economies; Marginal revenue product; Big five firm; CPA partner compensation; Production function

1. Introduction Considerable change was evident in the public accounting industry in recent years even before the travails of Andersen made news headlines. The recent increase in merger and acquisition (M&A) activity is often attributed to a Certified Public
$ The authors acknowledge the insightful comments and suggestions received from Masako Darrough (the referee), S.P. Kothari (the editor), and several senior and retired partners at leading public accounting firms that helped shape the research questions and analyses. *Corresponding author. Tel.: [phone]; fax: [phone]. E-mail address: [e-mail] (R.D. Banker).

0165-4101/03/$ - see front matter r 2003 Elsevier Science B.V. All rights reserved.

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