Is Audit Market Concentration Associated with Audit Pricing and Financial Reporting Quality? Evidence from the Banking Industry

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 4: Audit Fees: Measures, Markets, and Real Earnings Management

Abstract

Regulators are concerned that auditors with large market shares could use their market power to greatly influence audit price and reduce audit quality. We contribute to the literature by examining the relation between auditor concentration in the banking industry and audit fees as well as two aspects of banks’ financial reporting quality: earnings management via lower loan loss provisions (LLP) and the relation between current LLP and future loan charge-offs (LLP validity). We find that for clients of Big 5 auditors, audit fees are increasing at higher levels of concentration, consistent with concerns expressed by regulators. No such association is observed for clients of non-Big 5 auditors. We do not find a relation between auditor concentration and abnormal LLP for clients of Big 5 auditors. However, we observe a negative relation between concentration and income-increasing abnormal LLP for clients of non-Big 5 auditors. We do not observe an association between auditor concentration and LLP validity for both clients of Big-5 auditors and clients of non-Big5 auditors. We believe our findings are potentially relevant to regulators and others concerned about the effects of auditor concentration in the banking industry.

Authors

• Gopal V. Krishnan, American University

• Yinqi Zhang, American University