How Is the Audit Market Affected by Characteristics of the Non-Audit Services Market?

59 Pages Posted: 2 Aug 2018 Last revised: 2 Feb 2021

See all articles by Henry L. Friedman

Henry L. Friedman

University of California, Los Angeles (UCLA) - Accounting Area

Lucas Mahieux

Tilburg University - Tilburg University School of Economics and Management

Date Written: February 2, 2021

Abstract

How can features of the markets for audit and non-audit services (NAS) affect an audit firm's incentives to invest in audit quality, average audit quality, and social welfare? We address these questions in a model focusing on competition in both audit and NAS markets. We show that, when audit and NAS demand are positively correlated, prohibiting auditors from providing NAS to audit clients leads to higher investments in audit quality, but can decrease average audit quality if marginal clients switch to lower-quality auditors. The effect on social welfare can be positive or negative, depending on the distribution of clients' service demands. General bans on auditor provision of NAS can, via similar channels, increase or decrease audit quality and social welfare. Overall, our findings suggest a more nuanced view of how regulating an auditor's provision of NAS might affect audit quality and social welfare, and are driven by the effects of multi-market competition on the auditor's incentives to invest in audit quality, rather than previously identified auditor independence or knowledge spillover channels.

Keywords: Audit quality, Auditing services, Non-audit services, Competition

JEL Classification: L11, L13, L51, M41, M42

Suggested Citation

Friedman, Henry L. and Mahieux, Lucas, How Is the Audit Market Affected by Characteristics of the Non-Audit Services Market? (February 2, 2021). 29th Annual Conference on Financial Economics & Accounting 2018, Available at SSRN: https://ssrn.com/abstract=3212992 or http://dx.doi.org/10.2139/ssrn.3212992

Henry L. Friedman (Contact Author)

University of California, Los Angeles (UCLA) - Accounting Area ( email )

D406 Anderson Complex
Los Angeles, CA 90095-1481
United States

Lucas Mahieux

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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