The Effects of Audit Market Concentration and Auditor Reputation on Audit Quality: Evidence from Government Auditors

• In Event: Auditor Tenure, Quality, and Peer Review

Abstract

We investigate how a high degree of audit market concentration and auditor reputation affect audit quality. Using audit adjustments to student loan loss provision in government audits to construct a new measure for excess audit conservatism, we show that an audit market monopoly leads to excessively conservative audit adjustments to the provision, and thus, to lower audit quality. We also examine the effect of a positive shock to auditor reputation on audit quality. We find that before the reputation increase, monopolistic auditors require more conservative, yet not excessively conservative, adjustments than auditors in a competitive market. However, after the reputation increase, the adjustments become excessively conservative. This suggests that the combination of enhanced audit market concentration and high auditor reputation leads to excessive auditor conservatism. Using a non-monopolistic setting, we also find that auditors with more market power are more likely to include explanatory language references in their audit report, even though these references do not contain incremental information. Thus, we are able to extend our findings to a competitive market. Our study has implications to the ongoing debate regarding the impact of reduced competition in the audit market and its effect on audit quality.

Authors

• Zvi Singer, HEC Montreal

• Johnathon Cziffra, HEC-Montreal

• Steve Fortin, McGill University