Optimal Regulation of Auditing (original) (raw)
Related papers
2000
We study regulation of the auditing profession in a model where audit quality is unobservable and enforcing regulation is costly. The optimal audit standard falls short of the first-best audit quality, and is increasing in the economy's wealth, in the likelihood of a mistaken investment and in the size of typical investment. The model can encompass collusion between clients and
2013
I consider a game where external auditors may collude with the client firms they audit. Given mandatory audit fee disclosure (required by the SEC since 2000) and an imperfect public signal capable of detecting cheating and collusion with nonzero probability, I show that the possibility of collusion results in a highly concentrated market structure for external auditors, with firms only wishing to hire those auditors who have many other clients. This results in an auditing oligopoly even in the absence of economies of scale in auditing or quality differences across auditors.
The impact on the market for audit services of aggressive competition by auditors
Journal of Accounting and Public Policy, 2003
Supporters of direct uninvited solicitation activities argue that clients can make more informed choices of auditors when auditors are allowed to solicit prospective clients. In banned markets, auditors are allowed to submit bids to provide audit services only when invited by the client. This study provides theoretical models that examine the efficiency of client-auditor alignments in the banned and allowed market. We identify conditions under which realignment differences between the two markets occur and derive client losses in the banned market as compared to the allowed market. We also identify conditions under which independence may be impaired in the allowed market, consistent with the claims of solicitation opponents. However, we believe that, in view of the potential positive effects related to audit pricing and client-auditor alignment, restrictions on advertising or direct uninvited solicitation are not necessarily indicated. Instead, regulators or market mechanisms should insure that the independence (truthtelling) condition is so readily satisfied as to be virtually irrelevant. This can happen in one of two ways: (a) increased scrutiny, leading to an increased likelihood of discovery, or (b) increased penalties when an audit failure is discovered, leading to increased costs of an audit failure, or both.
Regulation of the auditing profession
Southern African Journal of Accountability and Auditing Research, 2005
The way in which the auditing profession is regulated is one of the factors adding value to, or undermining the value of the audit function. This article identifies the factors that are important to a regulatory system and evaluates the self-regulating structure of the auditing profession in terms of those factors. It appears that those elements that are important to a regulatory system are not adequately addressed by the auditing profession's current regulations. The fundamental reason for this can be traced back to the composition and financing of the regulator.
The Auditor and the Firm: A Simple Model of Corporate Cheating and Intermediation
2005
We apply a game-theoretic model to the analysis of the recent spate of corporate scandals in which firms have cheated their investors, often with the aid of external auditors. We characterize the different types of equilibria that obtain for different parameter ranges in an auditor’s absence (the parameters we consider being “early signal accuracy” – a measure of transparency – and “withdrawal costs” – a measure of the liquidity of investments). We also analyze whether and under what conditions the presence of an informed auditor could lead to an improvement in the sense of honest behavior replacing cheating as the firms’ equilibrium strategy. In doing so we take into account the auditor’s incentives to collude with his clients or extort from them. We use our results to derive some policy predictions including those relating to the Sarbanes-Oxley reforms, and contrast the case of a firm-hired intermediary (like an auditor) with the situation in which an intermediary is hired by inve...
The economic impact of audit failures
Revista de Contabilidad, 2022
This paper examines the economic consequences associated with an audit failure in the field of statutory auditing services, by analyzing changes in the audit firm’s market share around the time of the investigation process undertaken by the Spanish Public Oversight Board. We explore the variations in audit market share by applying the difference in differences method to a treatment group of 70 sanctioned audit firms and a matched control group of 70 non-sanctioned audit firms. The period of analysis covers the years from 1999 to 2015. Our results show that the sanctioned audit firms suffered a significant decrease in their relative number of clients. Moreover, this measure of market share decreased not only after the publication of the sanction disclosure (which may be attributed to reputational losses) but also after the initiation of the investigation (which may be attributed to the firm’s reluctance to audit risky clients). Findings are similar for both small and large firms when...
The strategic role of non-audit services in audit markets
There has been an extensive debate about whether the joint provision of audit and non-audit services (NAS) impairs auditor independence and objectivity. Literature suggest that joint delivery of the audit and NAS may generate knowledge spillover effects that could lead to economic rents, integrity and increased audit quality. We model that markets are better off when audit firms provide NASs together where firms are indifferent between the benefits of economic rents and the independence costs. The findings have implications for audit profession, regulators and policy makers such as PCAOB deliberation over whether additional NAS should be banned or relaxed for auditors.
Perceived Audit Independence and Audit Market Structure
SSRN Electronic Journal, 2018
The audit market comprises a small group of large firms and a big group of smaller firms. We build upon the classic model presented by Magee and Tseng (1990) to shed light on auditor market structure. In particular, we focus on the perceived reputation cost borne by auditors that agree with managers on controversial accounting issues. We claim that when perceived reputation cost depends on the weight of a specific client relative to total income, larger audit firms can charge higher fees for the same audits, and clients are willing to pay those higher fees due to the premium paid by investors when audits are perceived to be of higher quality. Moreover, we find that market concentration produces a suboptimal output in which client firms cannot choose the auditor that maximizes their profits, and auditors cannot extract the maximum potential surplus, producing a social loss in the audit market.
Inherent Agency Conflict Built into the Auditor Remuneration Model
Comparative Economic Research, 2016
This paper provides a model for audit market interventions. The study asks whether interventions in the audit market result in excessive premiums at the cost of quality and independence. The model was tested based on a historical data sample of 1,927 companies’ fiscal year financial statements, observed for the period 2010–2013. The testing strategy combined statistical analysis of the market concentration and regression of abnormal results. The findings do not support, for the Polish market, the conclusion that the audit market is used as a leverage for consulting services. This paper discusses possibilities of systematic risk for policymakers as a result of the negative interaction between regulated and non-regulated markets.