Does Audit Market Concentration Harm Audit Quality?
Evidence from Audit Markets in 42 Countries
This article investigates a very important concern of regulators, both in the U.S. and around the world, that the large percentage of audits conducted by the "Big Four" audit firms may negatively impact overall audit quality. Some regulators and other market participants have voiced concerns and suggested that rules be enacted that encourage more audits by smaller, non-Big Four auditors.
The study looks at this issue by comparing the overall market share of audits of Big Four auditors compared to other, smaller auditors, within countries around the world. Results provide evidence that, contrary to regulators' concerns, audit quality is higher in countries where the Big Four firms conduct a larger percentage of audits. The explanation offered for this result is that in countries where there exists a higher demand for quality auditing, companies hire Big Four auditors at an increased rate due both to their ability to conduct higher-quality audits, as well as their incentive to protect their global "brand name" reputation. Consequently, it appears that the relatively high market share enjoyed by the Big Four audit firms is a result of the demand for high-quality auditing in a country. This suggests that regulators should be very careful in enacting laws that forcibly transfer audit market share to smaller, local auditors as this could actually end up having a negative impact on audit quality.
The study also investigates whether the dominance in market share by one specific Big Four auditor affects audit quality. This is investigated by measuring the competition that is observed between the four Big Four auditors across countries. In other words, if one of the four audit firms dominates most of the audits conducted by Big Four audits in a country, they may possess decreased incentives to conduct high-quality audits (due to the decreased flexibility of a client company to switch to another Big Four audit firm). In other words, in these environments, the dominant Big Four audit firm may possess a kind of monopoly that allows them to charge higher fees, but at the same time reduce the costs of the audit that results in decreased audit quality. Conversely, in countries where the four firms have relatively equal market share, client companies can take advantage of this competition by hiring an audit firm that will conduct a high-quality audit at a more market-oriented fee rate. At the same time, Big Four audit firms have a national and/or global "brand name" reputation to protect. In countries where competition among the four is higher, audit firms have the incentive to not only charge competitive fees, they also have the incentive to conduct a high-quality audit.
In summary, the results of the study suggest that regulators may want to focus their attention on the competiveness of the audit market within the Big Four group of audit firms. At the same time, regulators should perhaps not be as concerned with the overall dominance of market share by the Big Four group of auditors taken as a whole, compared to smaller, more local audit firms.
Jere R. Francis is Curators' Professor, Robert J. Trulaske, Sr. Chair, & Director of Accountancy Ph.D. program at the Trulaske College of Business, University of Missouri-Columbia. Paul N. Michas is assistant professor of accounting at the Eller College of Management, University of Arizona. Scott Seavey is an assistant professor of accounting at the University of Nebraska.
Forthcoming in Contemporary Accounting Research.