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

49 Pages Posted: 27 Apr 2015

See all articles by Jessen L. Hobson

Jessen L. Hobson

University of Illinois at Urbana-Champaign

Robert Marley

University of Tampa

Mark J. Mellon

Northern Illinois University - Department of Accountancy

Douglas E. Stevens

Georgia State University - Robinson College of Business

Date Written: April 10, 2015

Abstract

We argue that the market for audit services closely resembles a common value procurement (seller’s) auction, where auditors generate a private estimate of the actual cost of an audit engagement prior to quoting the client a price. Thus, we conduct a systematic examination of audit pricing and audit quality in this market setting using two experiments. In experiment one, we examine a simplified setting in which auditors determine only audit price to investigate whether the “winner’s curse” found to be pervasive in the buyer’s version of the common value auction is also present in the seller’s version. In experiment two, we examine an enriched setting in which auditors determine both audit price and audit effort to investigate the robustness of our results and the effect of the winner’s curse on audit quality. In both experiments, we find that auditors fall prey to the winner’s curse and offer low ball prices on average. But we also find a differential learning process across the two markets. In experiment one, auditors learn to reduce their low ball pricing with market experience. In experiment two, however, auditors do not reduce their low ball pricing but instead reduce their audit effort when they contract at a low ball price. Our evidence suggests that low ball audit pricing arises due to the winner’s curse, and this source of low ball pricing poses a threat to audit quality.

Keywords: Keywords: winner’s curse, audit pricing, audit quality, common value auctions

JEL Classification: M41, C70, D44, D82

Suggested Citation

Hobson, Jessen L. and Marley, Robert and Mellon, Mark J. and Stevens, Douglas E., The Presence and Effect of the Winner's Curse in the Market for Audit Services: An Experimental Market Examination (April 10, 2015). Available at SSRN: https://ssrn.com/abstract=2599227 or http://dx.doi.org/10.2139/ssrn.2599227

Jessen L. Hobson

University of Illinois at Urbana-Champaign ( email )

4011 Business Instructional Facility
515 East Gregory Drive
Champaign, IL 61820
United States

Robert Marley

University of Tampa ( email )

401 W. Kennedy Blvd.
Box O
Tampa, FL 33606-1490
United States

HOME PAGE: http://www.ut.edu

Mark J. Mellon (Contact Author)

Northern Illinois University - Department of Accountancy ( email )

College of Business
DeKalb, IL 60115
United States

Douglas E. Stevens

Georgia State University - Robinson College of Business ( email )

P.O. Box 4050
Atlanta, GA 30303-3083
United States
404-413-7212 (Phone)
404-413-7203 (Fax)

HOME PAGE: http://robinson.gsu.edu/profile/douglas-e-stevens/

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