How Is the Audit Market Affected by Characteristics of the Non-Audit Services Market?
43 Pages Posted: 2 Aug 2018 Last revised: 2 Mar 2020
Date Written: February 25, 2020
How can features of the market for non-audit services (NAS) affect an audit firm's incentives to invest in audit quality, the price at which it offers audits, and the effects of prohibitions on providing NAS to audit clients? We address this and related questions in a model focusing on an audit firm that can provide both audit and NAS to a market of heterogeneous clients. We provide several interesting results. First, selling auditing and NAS jointly (i.e., bundling) may decrease audit quality because it changes the types of clients who purchase high-quality audits. Second, absent competition, a ban on NAS provision to audit clients can improve audit quality even without negative effects of NAS on auditor independence. Third, with NAS competition, bans on the provision of NAS to audit clients can decrease audit quality. These contrasting effects suggest a more nuanced view of how regulating an auditor's provision of NAS might affect audit quality, and operate through effects related to competition, pricing, and segmentation on ex ante quality investment incentives rather than previously identified auditor independence or knowledge spillover channels.
Keywords: Audit quality, Auditing services, Non-audit services, Competition
JEL Classification: L10, M41, M42
Suggested Citation: Suggested Citation