Could the Winner’s Curse Contribute to Low Balling in the Market for Audit Services? Some Experimental Evidence

Abstract

As with prior experimental studies in the literature, we examine a potential rationale for low balling behavior in the market for audit services. We argue that the market for audit services closely resembles a common value procurement (seller’s) auction. That is, a small number of audit firms typically offer a potential client an audit service whose cost is uncertain but similar across all firms, and each firm must estimate the true cost prior to quoting an offer price. Thus, the winner’s curse could contribute to low balling in the market for audit services. To test this possibility, we examine the behavior of experimental audit markets that take the form of a common value procurement auction. We find that auditors in our auction markets fall prey to the winner’s curse and low ball their audits on average. Low balling behavior is reduced but not eliminated with experience. In contrast with the extant literature’s characterization of low balling as an intentional, rational response to the expectation of future quasi-rents, we document a form of low balling that is an unintentional, behavioral response to cost uncertainty within a competitive market. We discuss the potential for this form of low balling to impair auditor independence.