An Analysis of the GAO Study on Audit Market Concentration

By Robert Bloom and David Schirm

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APRIL 2008 - The objectives of a recent Government Accountability Office (GAO) study were to evaluate the market concentration for audits of public companies, to consider the ability of small and mid-sized audit firms to reduce such concentration, and to analyze other proposals for reform.

The study consisted of a random sample of 595 of the roughly 6,000 publicly held U.S. companies of all sizes as well as interviews with interested parties, including public companies, audit firms, investors, academics, and regulators. Additionally, the GAO surveyed 434 U.S. auditing firms with at least one public company client, and met with representatives of each of the Big Four.

The report ( contains six sections: 1) results in brief; 2) background; 3) an analysis of the finding that large companies see limited choices, but no apparent significant effect on fees; 4) an analysis of the finding that small and mid-sized firms face challenges in auditing large public companies; 5) proposals to address those issues; and 6) GAO comments and evaluation. The report’s six appendices cover the methodology used in the study, other issues on audit market concentration, an analysis of auditor changes, trends in audit costs and quality, and an econometric analysis of the impact of concentration on audit fees. The report also includes 13 tables and 14 figures.


The study found that 82% of the large public companies surveyed see their auditor choice as limited to the Big Four because those firms have the technical expertise, capacity, and reputation to undertake those examinations. Sixty percent of those companies view competition in the audit sector as inadequate. Most of the small public companies surveyed, however, tended to be satisfied with the nature of their audit choices.

Large public companies contend that small and mid-sized audit firms lack the capacity (e.g. international outreach), if not also the technical know-how and reputation, to adequately service their needs. Moreover, many of these audit firms do not appear interested in undertaking those assignments in view of the higher risk associated with auditing large companies. A key drawback to expansion for small and mid-sized audit firms is the difficulty of attracting, developing, and retaining appropriate staff.

The analysis of concentration in the market for public company audits followed the preferred practice of determining the proportion of each audit firm’s share of revenues collected from audit clients. Measuring revenues as the total amount of audit fees, the GAO found the four largest audit firms collected 94% of all audit fees paid by public companies in 2006, slightly less than the 96% collected in 2002. As identified in the GAO’s 2003 study, such a concentration of revenues received by the four largest firms indicates a tight oligopoly. A standard statistical measure of market power, the Hirschman-Herfindahl Index (HHI), is calculated as the sum of the squares of market shares for each audit firm. The HHI for all audit firms in 2006 was 2,300. Both the Department of Justice (DOJ) and the Federal Trade Commission (FTC) consider an HHI value above 1,800 as indicative of a highly concentrated market. In a further analysis, segregating audit markets by industry and region, GAO found HHI values indicative of concentrated markets in audit services. While audit firms with 2006 audit revenues greater than $500 million are highly concentrated based on the HHI, firms with revenues between $100 million and $500 million are moderately concentrated, and firms with less than $100 million in revenues are not concentrated. Audit firms with audit revenues of $500 million or less have HHI values indicating less market concentration in 2006 than in 2002.

A primary concern with a tight oligopoly market structure is that a lack of price competition may result in oligopoly firms using their market power to increase the price of their goods or services. To assess the impact of market concentration of audit firms on fee revenue, the GAO analyzed the statistical relationships between audit fees paid by more than 12,000 companies from 2000 through 2006. It looked at a number of determinants, including the HHI measures of audit firm concentration; total assets of the audited company; percentage of the market held by a company’s auditor of record; whether the company’s fiscal year ends in a busy period; whether the company completed a Sarbanes-Oxley Act (SOX) section 404 internal control audit; and the number of times the company changed auditors.

Using advanced econometric models, factors other than concentration appear to explain variations in audit fees across firms and over time during 2000–2006. Companies purchasing audit services in more-concentrated industries do not appear to be paying higher audit fees than companies in less-concentrated industries. Some evidence indicates that large companies (more than $250 million in assets in 2006) in audit markets that are 10% more concentrated than average (as measured by HHI) paid about half a percent more in fees than other large companies. Companies that completed SOX section 404 internal control audits paid audit fees 45% higher than companies that did not have section 404 audits, making this a much more significant factor than size.

While the level of audit fees appears to be explained by factors other than concentration, the GAO report concludes that the limitations of the data do not allow a determination that audit fees are competitive overall, or that individual companies paid competitive fees. Segregated by industry, individual accounting firms appear to have charged higher fees in more-concentrated industries. Within such industries, companies of all sizes appear to pay similar premiums, suggesting that the premiums pay for audit industry expertise. Furthermore, the GAO found no compelling evidence that audit quality was compromised due to market concentration. The latter finding is based not on the econometric analysis, but on interviews and surveys of market participants.


The study considered various proposals for reform, including:

  • Placing a ceiling on auditor liability;
  • Having regulators pursue actions against wayward audit partners rather than entire firms;
  • Allowing external ownership of audit firms;
  • Setting up a common technical expertise unit for small audit firms to tap;
  • Establishing an accreditation agency for audit firms; and
  • Having insurance companies hire auditors and having public companies pay premiums to the insurers based on the perceived audit risk.

In considering the various proposals for reform, the GAO found that each proposal has both benefits and disadvantages. Furthermore, in the view of market participants, these proposals for reform have limited effectiveness, feasibility, and benefit.

In conclusion, the study found a “lack of significant adverse effect of concentration in the current environment and that no clear consensus exists on how to reduce concentration.” Failure of one of the Big Four, the study noted, would exacerbate this problem. While the GAO analyzed several proposals to mitigate auditor concentration, the agency decided not to advocate any of them at this time. The GAO made no recommendations for change, clearly indicating that it does not think it is time to press the panic button.

Robert Bloom, PhD, is a professor of accountancy, and David Schirm, PhD, is a professor of finance, both at the Boler School of Business of John Carroll University, University Heights, Ohio.




















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