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    Competition in the Audit Market: Policy Implications.
    research summary posted January 19, 2016 by Jennifer M Mueller-Phillips, tagged 15.0 International Matters, 15.04 Audit Firm Rotation 
    Competition in the Audit Market: Policy Implications.
    Practical Implications:

    This study predicts economic effects of both mandatory audit firm rotation and the contraction of the audit market to 3 major audit firms. The authors estimate that mandatory audit firm rotation would reduce consumer surplus ranging from $2.7 billion to $5 billion depending on the length of time between required rotations (10 or 4 years, respectively). They also find that the contraction of supply from 4 major audit firms to 3 major audit firms would reduce client firms’ surplus between $1.4 and $1.8 billion. Finally, the authors estimate that audit fees would increase for client firms by approximately 12% (5%) as a result of mandatory audit firm rotation (audit firm contraction). Therefore, it appears that the occurrence of either of these events would be damaging to client firms. However, the estimates do not take into consideration the potential benefits associated with mandatory audit firm rotation such as increased auditor independence and possibly higher audit quality.


    Gerakos, J. and C. Syverson. 2015. Competition in the Audit Market: Policy Implications. Journal of Accounting Research 53 (4):725-775.

    auditing, mandatory rotation, competition
    Purpose of the Study:

    This study explores the effects of two possible market scenarios within the audit market that have been the focus of policy discussions: 1) Mandatory firm rotation and 2) Supply concentration resulting from contraction of “Big 4” audit firms to 3 audit firms. Policy makers are interested in the audit market due to its role in the transparency of capital markets, but also because of its unique combination of mandated demand and concentrated supply. For example, publicly traded firms require an audit by the SEC, yet 67% of audit engagements and 94% of audit fees are concentrated within only 4 audit firms. Thus, policy makers have frequently expressed concerns about auditor independence which has led to the PCAOB exploring the possibility of mandatory audit firm rotation. Policy makers have also been concerned of resulting effects if further supply concentration occurred, potentially as a result of litigation from negligence. This study estimates the demand for audit services among publicly listed firms to develop a framework of how client choose their audit firms which is then used to measure in dollar terms values of substitutability of audit firms for clients. Resulting information is then combined across thousands of client firms’ choices to determine the valuation of audit firms by different clients. More specifically, the authors calculate the monetary transfer that would be necessary to compensate clients for the loss of choice of one Big 4 audit firm.  

    Design/Method/ Approach:

    The data used in this research is from a sample of SEC registrants between 2000 and 2010 and gathered publicly available data of audit fees and restatements from Audit Analytics and from other publicly available sources. Data was collected prior to January 2014.  

    • For U.S. publicly traded firms, mandatory audit firm rotation would induce consumer surplus losses of approximately $2.7 billion ($4.7-$5.0 billion) if rotation were required after 10 (4) years.
    • The exit of one of the Big 4 firms would reduce client firms’ surplus by $1.4-$1.8 billion.
    • Audit fee increases could range from $0.75 to $1.3 billion per year as a result of mandatory rotation and $0.47-0.58 billion per year if a Big 4 firm ‘disappeared’.
    • Result is economically significant compared to total audit fees for public firms of $11 billion in 2010.
    International Matters
    Audit Firm Rotation