Audit Market Regulation and Earnings Characteristics : Cross-Country Evidence on the Role of the Audit Market Structure

Abstract

Limited evidence exists on the effects of the audit market regulation and the structure of the audit market on audit quality. We explore the link between regulation and three key earnings characteristics - discretionary accruals, loss avoidance, and conditional conservatism - by using time-series data from 2002 to 2011 on seven regulatory measures in 29 countries to identify the marginal effects of these measures on audit quality. We find a quality-increasing effect from the restriction of non-audit services, disclosure of auditor fees, and the existence of fee caps, whereas a mandatory rotation of the audit firm reduces the earnings’ quality. Our results are confirmed by a changes specification and a placebo test. Further tests show that these effects depend on the audit market’s concentration, whereas competition seems less important. In particular, regulations are more likely to be effective if the concentration is low. Our findings are helpful for regulators in determining the possible consequences of new regulations on the quality of audited financial statements.