The Dark Side of Audit Market Competition

68 Pages Posted: 8 Dec 2020 Last revised: 21 Jun 2022

See all articles by Yue Pan

Yue Pan

Xiamen University - School of Economics

Nemit Shroff

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Pengdong Zhang

Sun Yat-sen University (SYSU)

Multiple version iconThere are 2 versions of this paper

Date Written: June 20, 2021

Abstract

This paper examines the relation between audit market competition and audit quality. We use the staggered introduction of bullet trains in different Chinese cities as shocks to travel time between audit clients and prospective audit firms, which increases the threat of competition for incumbent audit firms. The inception of bullet train connectivity leads to a 4.5 percentage point (pp) increase in the probability of GAAP violations and a 1.7 pp decrease in the probability of modified audit opinions for clients headquartered in connected cities. Bullet train connectivity is also followed by a 1.6 pp decrease in income-decreasing audit adjustments but no change in income-increasing audit adjustments. The negative relation between bullet train connectivity and audit quality is 1) stronger when bullet trains put greater competitive pressure on incumbent auditors and 2) weaker when clients demand high audit quality. Our paper provides plausibly causal evidence that competition lowers audit quality.

Keywords: Accounting, Auditing, Audit Quality, China, Competition, Financial Reporting

JEL Classification: M4, M42, D40, D43, G3

Suggested Citation

Pan, Yue and Shroff, Nemit and Zhang, Pengdong, The Dark Side of Audit Market Competition (June 20, 2021). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3721517 or http://dx.doi.org/10.2139/ssrn.3721517

Yue Pan

Xiamen University - School of Economics ( email )

China

Nemit Shroff (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main St.
E62-679
Cambridge, MA MA 02142
United States
6173240805 (Phone)

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=51407&co_list=F

Pengdong Zhang

Sun Yat-sen University (SYSU) ( email )

135, Xingang Xi Road
Guangzhou, Guangdong 510275
China

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