Do Entry Barriers to the Public Company Audit Market Deter Low Quality Audit Firms?

52 Pages Posted: 6 May 2020

See all articles by Andrew Kitto

Andrew Kitto

University of Massachusetts Amherst

Phillip T. Lamoreaux

Arizona State University

Devin Williams

University of Illinois; University of Florida

Date Written: April 2020

Abstract

Many legal jurisdictions, including the U.S. and U.K., have passed regulations to address the potential negative impacts of a lack of competition and high concentration in public company audit markets. One consequence of increased regulations, desired or not, is that they have presumably increased barriers to enter the public company audit market. An alternative view is that high barriers prevent the entry of low-quality entrants (von Weizsacker, 1980; Grossman and Horn, 1988). This study investigates the supply of, and demand for, first time public company audit firms in the U.S., firms that presumably overcame these barriers to enter the market. We document that since 2004, 275 unique audit firms have entered the U.S. public company audit market. We find evidence that these first time auditors provide lower quality audits as measured by a higher likelihood of client restatements, PCAOB-identified audit deficiencies, PCAOB enforcement actions, and lower auditor effort as measured by audit engagement hours. We also find evidence that these firms receive lower fees and that clients are significantly more likely to subsequently switch away from first time audit firms. Collectively, our results suggest that existing barriers to entry to the public company audit market do not prevent the entry of low-quality auditors, and clients do not fully infer quality based on first timers’ pre-entry quality signals.

Keywords: Audit market, audit competition, non-Big 4 audit firms, audit quality, PCAOB

JEL Classification: D02, D43, G38, K23, M41, M42, M48

Suggested Citation

Kitto, Andrew and Lamoreaux, Phillip T. and Williams, Devin, Do Entry Barriers to the Public Company Audit Market Deter Low Quality Audit Firms? (April 2020). Available at SSRN: https://ssrn.com/abstract=3572688 or http://dx.doi.org/10.2139/ssrn.3572688

Andrew Kitto

University of Massachusetts Amherst ( email )

Amherst, MA 01003-4910
United States

Phillip T. Lamoreaux (Contact Author)

Arizona State University ( email )

Tempe, AZ 85287
United States

Devin Williams

University of Illinois ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

University of Florida ( email )

PO Box 117165, 201 Stuzin Hall
Gainesville, FL 32610-0496
United States

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