The Interdependence Between Audit Market Structure and the Quality of Financial Reporting: The Case of Non-Audit Services

Christopher Bleibtreu () and Ulrike Stefani ()
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Christopher Bleibtreu: Department of Economics, University of Konstanz, Germany
Ulrike Stefani: Department of Economics, University of Konstanz, Germany

No 2012-01, Working Paper Series of the Department of Economics, University of Konstanz from Department of Economics, University of Konstanz

Abstract: Recently, the Commission of the European Communities has put up for discussion various reform proposals intended to enhance the reliability of audits and to re-establish trust in the financial market. In particular, the EU Commission seeks to strengthen auditor independence and to decrease the high level of audit market concentration. Using the example of a ban on the joint provision of audit and non-audit services, we show that strengthening auditor independence and reducing market concentration may represent competing goals. Neglecting such interdependencies in the debate on regulation could thus lead to ill-advised regulatory decisions. Our arguments are based on a model that integrates a strategic auditor-manager game into a circular market matching model. We show that prohibiting general consulting services can result in a decrease in the equilibrium number of audit firms (i.e., in an increase in market concentration). Moreover, a ban on the joint supply of general consulting services might even have negative effects on the quality of audited financial statements, since the average probability that managers will misreport increases. Our model predicts the opposite effects for a prohibition on audit-related consulting services that managers purchase in order to tempt auditors to compromise their independence. The effects of a ban on “single-provider” auditing and consulting thus depend on the kind of services an auditor is allowed to offer and, in particular, on the point in time at which consulting services are negotiated.

Keywords: Auditing; Non-Audit Services; Audit Market Concentration; Auditor Independence; Quality of Audited Financial Statements (search for similar items in EconPapers)
JEL-codes: D43 L11 M42 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2012-02-13
New Economics Papers: this item is included in nep-acc and nep-com
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Citations: View citations in EconPapers (1)

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