The Presence and Effect of the Winner's Curse in the Market for Audit Services: An Experimental Market Examination

Abstract

ABSTRACT We argue that the market for audit services resembles a common value procurement auction in that there is common uncertainty regarding audit cost and auditors generate a private estimate of cost prior to quoting a price. We examine two audit markets that take this form of market institution. First, we examine a simple market setting where auditors determine only price and interact with robot clients. Next, we examine an enriched market setting that incorporates theoretically important features of the market for audit services. We find that auditors in the simple audit market learn to avoid the winner's curse with pricing experience but this learning effect is hindered in the enriched market. Auditors in the enriched market reduce audit effort when they suffer the winner's curse. Our evidence suggests that low balling can occur due to the winner's curse, and this source of low balling poses a threat to audit quality.