Tacit Collusion, Leader Reputation Damage and Audit Market Instability


Speaker:Marleen Willekens, KU Leuven, Belgium
Website: http://www.econ.kuleuven.be/eng/fetew/medewerker/userpage.aspx?PID=297
Date: Wednesday 4 February 2015
Time: 14:00
Location: Constantine Leventis Teaching Room, Building One

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In this paper we investigate whether tacit collusion incentives impact audit market competition between audit firms by executing an analysis of audit market instability. In addition we also examine whether damage to a market leader’s reputation affects the instability of the audit market. Based on prior literature in the industrial organizations area, we hypothesize that competition between audit firm rivals in multiple market segments (which we label ‘multimarket contact’) facilitates tacit collusion and is therefore negatively associated with market instability, whereas client concentration reduces tacit collusion incentives and hence is expected to be positively associated with market instability. Furthermore, we predict that client restatements adversely affect an audit market leader’s high-quality reputation which then disrupts the market equilibrium and induces instability. We measure market instability by two proxies: first, ‘leader dethronement’ which captures the instability of the audit market leadership position, and second, ‘market share mobility’ which captures the market instability of all competing audit firms in the market. Consistent with prior research (see, Numan and Willekens 2012; Francis et al. 2005), we define an audit market segment as an industry within a U.S. Metropolitan Statistical Area (MSA) and find that multimarket contact between the incumbent audit firm and its rivals is negatively related with our market instability proxies, whereas client concentration is positively related with these proxies. Finally, restatements by a leader’s client are positively associated with leader dethronement but has no significant effect on market share mobility.

Keywords: tacit collusion, leader reputation, market instability