Regulating the Market for Audit Services: A Game Theoretic Approach

45 Pages Posted: 12 Oct 2018 Last revised: 19 Dec 2019

See all articles by Konstantinos Eleftheriou

Konstantinos Eleftheriou

University of Piraeus

Iliya Komarev

EMLYON Business School - Casablanca Campus ; Abu Dhabi University - College of Business

Paul J. M. Klumpes

Nottingham Trent University

Date Written: September 22, 2018

Abstract

We apply game theory to model how alternative mandatory audit firm rotation regimes can affect the strategic interaction between auditee and auditor firms, and analyze potential consequences on detection risk and impairment of auditor skepticism. The major results suggest that, (1) relative to an initial state with no rotation requirement but high probability for impaired auditor skepticism, imposing either short-term or long-term mandatory audit firm rotation will remove the threat to auditor skepticism and lead to higher audit fees and lower detection risk; (2) relative to long-term mandatory audit firm rotation, imposing a short-term rotation will lead to lower audit fees and higher detection risk, resulting from greater informational frictions. We further find that supplementary regulatory instruments such as increased scrutiny of the auditee and/or auditor can be used to lower the detection risk and increase the audit quality. The public policy and empirical implications of our findings are discussed.

Keywords: Auditing, Game theory, Regulation, Rotation

JEL Classification: M42, M48

Suggested Citation

Eleftheriou, Konstantinos and Komarev, Iliya and Klumpes, Paul J.M., Regulating the Market for Audit Services: A Game Theoretic Approach (September 22, 2018). Available at SSRN: https://ssrn.com/abstract=3253641 or http://dx.doi.org/10.2139/ssrn.3253641

Konstantinos Eleftheriou (Contact Author)

University of Piraeus ( email )

Department of Economics
Karaoli and Dimitriou 80
Piraeus, ATTIKI 18534
Greece

Iliya Komarev

EMLYON Business School - Casablanca Campus ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

Abu Dhabi University - College of Business ( email )

PO Box 59911
Abu Dhabi, Abu Dhabi 59911
United Arab Emirates

Paul J.M. Klumpes

Nottingham Trent University ( email )

Burton Street
Nottingham NG1 4BU, NG1 4LN
United Kingdom

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