Regulatory Oversight and Audits in Capital Markets

• In Event: Continental Breakfast - Research and Education Forum
  In Roundtable Session: Table 11: Audit Regulation

Abstract

This paper analyzes the impact of regulatory oversight on audit quality, the structure of the audit market, social surplus, and audit fees. Our analyses suggest that regulatory oversight does not improve audit quality of all auditors, but it can improve the overall audit quality of an audit market by incentivizing inefficient or lower ability auditors to exit the market, and by allowing participating auditors to commit to higher audit effort. The improvement of overall audit quality is not necessarily beneficial to investors because regulatory oversight can induce over-investment in audit effort if auditing standards are too tough. However, when the legal regime is weak, regulatory oversight can improve social surplus by incentivizing auditors to comply with standards that are closer to the first-best. Furthermore, regulatory oversight does not have an impact on audit fees of auditors who remain compliant with auditing standards under the two regimes (i.e. with and without regulatory oversight) but increases the fees of auditors who remain noncompliant or switch from noncompliance to compliance with auditing standards. Additionally, regulatory oversight can substitute for a weak legal system in disciplining auditors, but the effect of the legal system on the composition of auditors in the markets is not substitutable by regulatory oversight. Our results enhance understanding of the complex relation between regulatory oversight and audit markets, and provide policy implications for regulators.

Authors

• Minlei Ye, University of Toronto

• Dan A. Simunic, The University of British Columbia