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The Interdependence Between Audit Market Structure and the Quality of Financial Reporting: The Case of Non-Audit Services

  • Christopher Bleibtreu

    ()

    (Department of Economics, University of Konstanz, Germany)

  • Ulrike Stefani

    ()

    (Department of Economics, University of Konstanz, Germany)

Recently, the Commission of the European Communities has put up for discussion various reform proposals intended to enhance the reliability of audits and to re-establish trust in the financial market. In particular, the EU Commission seeks to strengthen auditor independence and to decrease the high level of audit market concentration. Using the example of a ban on the joint provision of audit and non-audit services, we show that strengthening auditor independence and reducing market concentration may represent competing goals. Neglecting such interdependencies in the debate on regulation could thus lead to ill-advised regulatory decisions. Our arguments are based on a model that integrates a strategic auditor-manager game into a circular market matching model. We show that prohibiting general consulting services can result in a decrease in the equilibrium number of audit firms (i.e., in an increase in market concentration). Moreover, a ban on the joint supply of general consulting services might even have negative effects on the quality of audited financial statements, since the average probability that managers will misreport increases. Our model predicts the opposite effects for a prohibition on audit-related consulting services that managers purchase in order to tempt auditors to compromise their independence. The effects of a ban on “single-provider” auditing and consulting thus depend on the kind of services an auditor is allowed to offer and, in particular, on the point in time at which consulting services are negotiated.

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Paper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2012-01.

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Length: 44 pages
Date of creation: 13 Feb 2012
Date of revision:
Handle: RePEc:knz:dpteco:1201
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