Competition in the Audit Market: Policy Implications∗

The audit market’s unique combination of features—its role in capital market transparency, mandated demand, and concentrated supply—means it receives considerable attention from policymakers. We explore the effects of two market scenarios that have been the focus of policy discussions: a) further supply concentration due to one of the “Big 4 ” auditors exiting and b) mandatory audit firm rotation. To do so, we first estimate publicly traded firms ’ demand for auditing services, treating services provided by each of the Big 4 as differentiated products. We then use those estimates to calculate how each scenario would affect client firms ’ consumer surplus. We estimate that, conservatively, exit by one of the Big 4 would reduce client firms’ surplus by $1.2–1.8 billion per year. These estimates reflect only firms ’ lost options to hire the exiting auditor; they do not include the likely fee increases resulting from less competition among auditors. We calculate that the latter could result in audit fee increases between $0.3–0.5 billion per year. Such losses are substantial; by comparison, total audit fees for public firms were $11 billion in 2010. We find similarly large impacts from mandatory audit firm rotation, estimating consumer surplus losses at approximately $2.4–3.6 billion if rotation was required after ten years and $4.3–5.5 billion if rotation was mandatory after only four years