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Regulating the Market for Audit Services: A Game Theoretic Approach

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  • Konstantinos Eleftheriou
  • Iliya Komarev
  • Paul Klumpes

Abstract

We apply game theory to model how alternative mandatory audit firm rotation regimes can affect the strategic interaction between auditee and auditor firms, and analyze potential consequences on detection risk and impairment of auditor scepticism. The major results suggest that: (1) relative to an initial state with no rotation requirement but high probability for impaired auditor scepticism, imposing either short‐term or long‐term mandatory audit firm rotation will remove the threat to auditor scepticism and lead to higher audit fees and lower detection risk; (2) relative to long‐term mandatory audit firm rotation, imposing a short‐term rotation will lead to lower audit fees and higher detection risk, resulting from greater informational frictions. We further find that imposing supplementary regulatory instruments, such as increased regulatory scrutiny of the auditee and/or auditor, can be used to lower the detection risk and increase audit quality. We discuss implications of these findings for empirical research.

Suggested Citation

  • Konstantinos Eleftheriou & Iliya Komarev & Paul Klumpes, 2023. "Regulating the Market for Audit Services: A Game Theoretic Approach," Abacus, Accounting Foundation, University of Sydney, vol. 59(3), pages 697-734, September.
    • Handle: RePEc:bla:abacus:v:59:y:2023:i:3:p:697-734
    DOI: 10.1111/abac.12278
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    References listed on IDEAS

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