The Auditing Oligopoly and Lobbying on Accounting Standards
Executive Summary — The US auditing industry has been characterized as an oligopoly, which has successively tightened from eight key players to four over the last 25 years. This tightening is likely to change the incentives of the surviving big auditors, with implications for their role in our market economy. Motivated by the economic and public policy implications of the tightening audit oligopoly, the authors of this paper investigate the changing relation between the big firms and accounting standards. Accounting standards are a key input in the audit process and, through their effects on financial reporting, can impact capital allocation decisions in the economy. Results show that the big auditors are more likely to identify decreased reliability in proposed standards as the auditing oligopoly has tightened: This suggests that big auditors perceive higher litigation and political costs from the increased visibility that accompanies tighter oligopoly. The findings are also consistent with tighter oligopoly decreasing competition among the surviving firms to satisfy client preferences in accounting standards. The findings do not support the concern that tightening oligopoly has rendered the surviving big firms "too big to fail." Key concepts include:
- This research investigates the impact of the tightening audit oligopoly on "Big Four" auditors' propensity to discuss decreased "reliability" in accounting standards proposed by the Financial Accounting Standards Board (FASB).
- "Reliability" is a key attribute of accounting. Moreover, reliability is directly relevant to auditors because it entails "verifiability," another key aspect of auditing.
- As the auditing oligopoly has tightened, big auditors are more prone to eschew the judgment and risks inherent in less reliable accounting standards.
- Results provide some descriptive evidence on the evolution of "rules" over "principles" in U.S. Generally Accepted Accounting Principles (GAAP).
- The growth of rules-based accounting standards is significant because it can result in a collectivization of auditing and financial reporting risks in ways that can be sub-optimal for capital allocation.
- Results do not support the notion that the tightening oligopoly has rendered the surviving big audit firms "too big to fail."
We examine how the tightening of the US auditing oligopoly over the last twenty-five years—from the Big 8 to the Big 6, the Big 5, and, finally, the Big 4-has affected the incentives of the Big N, as manifest in their lobbying preferences on accounting standards. We find, as the oligopoly has tightened, Big N auditors are more likely to express concerns about decreased "reliability" in FASB-proposed accounting standards (relative to an independent benchmark); this finding is robust to controls for various alternative explanations. The results are consistent with the Big N auditors facing greater political and litigation costs attributable to their increased visibility from tightening oligopoly and with decreased competitive pressure among the Big N to satisfy client preferences (who usually demand accounting flexibility at the expense of reliability). The results are inconsistent with the claim that the Big N increasingly consider themselves "too big to fail" as the audit oligopoly tightens.