The Effects of Audit-Firm Monopoly Power within Local Audit Markets

• In Event: Audit Market Competition & Audit Location

Abstract

This study examines auditors (monopolist auditors) who monopolize audit markets defined as a particular industry within a city (Numan and Willekens 2012), and their pricing strategy as well as audit quality. I document that the monopolist auditors charge lower fees than industry specialist auditors, suggesting that the monopolist auditors discount audit fees to deter new entrants. This result is consistent with monopolists’ limit pricing strategy (Milgrom and Roberts 1982), but contrasting with regulators’ concerns about monopoly pricing. I also find that the monopolist auditors more frequently fail to detect misstatements than industry specialist auditors. This is consistent with regulators’ concerns about market-dominating auditors’ complacency (GAO 2003, 2008). In cross-sectional tests, I document that the limit pricing is predominantly evident among clients in homogenous industries, where the monopolist auditors would fear more for new entrants because the monopolist auditors would forgo more profits generated from clients in homogeneous industries. On the other hand, I find the limit pricing is less evident among clients in complex industries where the monopolist auditors would have less fear for new entrants because entry barrier in complex industry is high. Finally, I find the monopolist auditors’ audit failures are more pronounced when market competition within a city is low, where the monopolist auditors would have even lower incentives to improve audit quality.

Author

• Jaehan Ahn, University of Oklahoma