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03 Jul 2017

Research: Audit Market Dynamics: the French Perspective on Mandatory Joint Audits

Lamya Kermiche, professeur associé à Grenoble Ecole de Management au département Finance, Innovation et Gouvernance.

The audit industry has garnered increasing attention from policy makers, in particular since the demise of Arthur Andersen in 2002. The industry is marked by the fact it has only four major players known as the Big 4. The concentration of audit activities carried out by these four players has raised concerns about risks both in terms of demand and supply. The authors of this latest study explore the issue of mandatory joint audits in France as a means of understanding how policy makers can mitigate audit market risks.

This article of Lamya Kermiche is the subject of the 37th Executive Summary by Grenoble Ecole de Management.

From the article

The Audit Market Dynamics in a Mandatory Joint Audit Setting – The French Experience
Journal of Accounting, Auditing and Finance, 2017, à venir
DOI : #10.1177/0148558X16680716
Kermiche Lamya, Piot Charles

The Big 4 (Deloitte Touche Tohmatsu, Ernst & Young, KPMG and PricewaterhouseCoopers) concentrate the majority of auditing activities in Europe. As a result, this situation presents risks in terms of demand and supply. The former translates to a lack of choice for public interest entities required to use auditing fi rms. The latter translates to reduced competition and potential detrimental effects on pricing and/or quality.

Europe recommends joint audits

At the European level, policy makers have considered several solutions to mitigate audit market concentration, including the use of joint audits, periodic re-tendering of audit engagements and the mandatory rotation of audit fi rms. In 2014, the European Commission recommended the use of joint audits that included a Big 4 (systemic) fi rm and a nonsystemic audit fi rm. The goal of such recommendations is to open the audit market and encourage the emergence of midtier European audit alternatives that can compete with the Big 4.

Research on the French audit market

As little academic research has been carried out on this question, the authors aimed to explore the impact of joint audits requirements on audit market dynamics. The researchers used data from the French audit market as almost all French listed companies are required to implement joint audits. At the same time, these French companies are free to choose any combination of co-auditors, which enabled the researchers to explore the balance between systemic and nonsystemic audit fi rm pairing.

They explored the attractiveness of each type of joint audit pairing over the short and long term. They considered two periods: fi rst, 1997-2003, during which there was signifi cant market concentration as the Big 6 merged into the Big 4; and second, a period of stability from 2003-2009, characterized by the Big 4. Using a Markovian analysis, the researchers explored how audit clients chose between combinations of Big 4 and smaller auditors. At equilibrium, this method produces long term market shares for the various joint audit combinations.

Joint audits favor market openness

Overall, conclusions drawn from the study support the European Commission's position on the potential benefi ts of joint audits. In terms of stability, the researchers found that a combination of two Big 4 fi rms was less attractive over the long term than two nonsystemic fi rms. They noted that a mixed combination of one Big 4 and one smaller fi rm remained the most attractive solution (54% of audit clients over the long term). Finally, they highlighted that in the case of joint audits involving only nonsystemic fi rms, long term performance was better for a combination involving one mid-tier fi rm instead of two local fi rms.

These fi ndings confi rm that the French joint audit system can be an effective solution to foster market openness and mitigate Big 4 dominance.

Key points

  • The high concentration of auditing activity by the Big 4 creates risks in terms of choice, pricing and quality
  • Market openness could be improved by joint audits that encourage audit clients to include mid-tier European or local firms.
  • Over the long term, joint audits using a Big 4 firm and a smaller firm are preferred by the majority (54%) of audit clients.
Mara Saviotti