Regulation, Competition and Independence in a Certification Society: Financial Reports vs. Baseball Cards

Abstract

Mandatory certification of the financial reports of publicly-held corporations by independent auditors has been a key element in U.S. regulatory framework to improve financial reporting. The economic consequences of mandatory certification remain controversial. Although each market is unique, comparative analyses of certification services across markets can yield useful insights into the value and consequences of mandatory audit of financial reports. Using a framework for analysis of certification services, we report: (1) descriptive data about certification activity for a range of private sector goods; (2) qualifications and interests of experts who provide online certification or opinion for a fee; and (3) analysis of an online market for certification of baseball card.

We find that (1) markets for certification services are ubiquitous in the economy, many with potential for conflicts of interest; (2) the grading scales vary from pass/fail to 100 points with greater use of the former by government agencies; (3) the unregulated market for baseball card certification is dominated by firms who also sell other services; (4) buyers of certification services are willing to pay more for stricter grading; and (5) the net returns to the purchase of stricter certification services are higher, i.e., there is little evidence of a race-to-the-bottom. These observations from unregulated markets for certification services raise interesting questions about several maintained assumptions about the federal regulation of certification of corporate financial reports (e.g., the importance of independence).

JEL Classification: M49, G34, G38