Dynamic Auditor Competition and Audit Quality in the United States

Abstract

Regulators and audit market participants have concerned that less competitive audit market makes auditors to reduce the incentives to conduct high-quality audits. While a few studies examine the effect of competition in the U.S. local audit markets, they report conflicting evidence using the static Herfindahl index which is arguably noisy in capturing the intensity of competition. The purpose of this paper is to provide evidence on the effect of dynamic auditor competition in local audit markets on audit quality. For this purpose, we employ a measure to capture the dynamic nature of audit market competition: the proportion of clients switching auditors in the local market. Employing this measure, we find evidence suggesting a positive relation between auditor competition and audit quality and that the relation is stronger in large MSAs and for clients whose relative importance to audit office is smaller. This paper adds to the competition-audit quality literature by utilizing dynamic measures of audit market structure. In addition, the findings in this paper provide important evidence in response to the regulatory concerns that low competition is harmful to audit quality in a sense that it can cause auditor complacency and less rigorous audit procedures.