The Effects of Audit-Firm Monopolies within Local Audit Markets
58 Pages Posted: 14 Feb 2018 Last revised: 16 Jul 2018
Date Written: July 14, 2018
This study identifies auditors who monopolize a city-industry audit market (i.e., monopolist auditors) and examines their pricing strategy as well as audit quality. I document that monopolist auditors charge lower fees than do industry specialist auditors. This result is consistent with a monopolists’ pricing strategy (i.e., limit pricing) to deter new entrants but contrasts with regulators’ concerns about monopoly pricing. I also find that monopolist auditors more often fail to detect misstatements than do industry specialist auditors. This is consistent with regulators’ concerns about market-dominating auditors’ complacency. In cross-sectional tests, limit pricing is predominantly evident in homogenous operation industries where more profits are at stake while it is less evident in industries requiring complex accounting, which operates as a natural barrier to entry. In addition, I find that monopolist auditors’ audit failures are more pronounced when the current market competition within a city is low. These findings suggest that auditors exhibit distinctive incentives when they lack the closest competitor.
Keywords: Monopoly, Audit market concentration, Industry specialist, Audit fees, Misstatement, Limit pricing, Complacency
JEL Classification: M40, M42, D40, D42
Suggested Citation: Suggested Citation