Audit Market

Abstract

Efficiency of any audit market is broadly measured by quality of audit. Audit quality, in turn, depends on two factors- (a) ability to identify misreporting and errors in financial statements; and (b) willingness to report such errors and/or misstatements. While the first factor relies on the skill and competence of auditors, the second one surely depends on independence of auditors. It is generally believed that large audit firms can ensure better audit quality as they employ more competent resources who have requisite auditing skill as well as knowledge of select sectors or industries. Smaller audit firms could not afford large number of efficient auditors for cost reasons. As a result, audit market internationally is dominated by the oligopoly of the so-called Big 4 audit firms (Deloitte, EY, PwC and KPMG). The evolution of audit market over the past three decades showed further concentration of the industry- from Big 8 auditors to Big 4 auditors (see figure in next page). Is such a level of concentration good for the audit market? Will this feature make the audit market less efficient? Answer to these questions lies in quality of audit rendered by Big 4 and other auditors. Whether Big 4 auditors provide higher audit quality is an empirical questions and evidences are mixed. Simunic and Stein (1987) suggest that having spent heavily on building their brand names, the Big 4 auditors have an incentive to protect their reputations by providing more credible financial reports. Another study (Becker et al, 1998) shows that Big 4 auditors were able to restrain audit clients from earning manipulations. Jaggi et al (2014) confirm firms audited by industry specialists reflect a better earnings quality compared to audits by non-specialists. There are counter evidences too. Lawrence et al (2011) find that the effects of Big 4 auditors on audit quality are insignificantly different from those of non-Big 4 auditors.