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The dark side of audit market competition |
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| Institution: | 1. School of Economics, Xiamen University, China;2. Massachusetts Institute of Technology, USA;3. School of Business, Sun Yat-sen University, China;1. A. B. Freeman School of Business, Tulane University, New Orleans, LA 70118, USA;2. Argyros School of Business & Economics, Chapman University, Orange, CA 92866, USA;3. School of Business Administration, University of Dayton, Dayton, OH 45469, USA;1. University of Kansas, 1654 Naismith Drive, Lawrence, KS, 66045, USA;2. San Diego State University, 5500 Campanile Drive, San Diego, CA, 92182-8230, USA;1. A.B. Freeman School of Business, Tulane University, USA;2. Lally School of Management, Rensselaer Polytechnic Institute, USA |
| 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: | Audit Quality Financial Reporting China Competition Conflicts of interest GAAP violations |
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