Audit Market Competition and Audit Quality

Policy makers have been interested in the impact of audit market competition (concentration) on audit quality. In this paper we study the relation between audit market competition at the MSA level (Herfindahl index of concentration) and audit quality (measured by discretionary accruals and the Dechow-Dichev (2002) measure of accrual quality). We find that higher audit market competition is associated with lower audit quality. We control for fixed year effects, therefore our results are unlikely to be affected by the decrease in competition due to Andersen's demise contemporaneous with an increase in audit quality because of regulatory measures such as SOX. Our results are robust to several sensitivity tests we perform in an attempt to rule out omitted variables correlated with client firms' MSA location. Our results are also robust to controls for endogeneity between audit market concentration and audit quality.