The Presence and Effect of the Winner's Curse in the Market for Audit Services: An Experimental Market Examination

What is it about?

We argue that the audit market resembles a common value procurement auction in that there is uncertainty regarding the cost of the audit and auditors generate a private estimate of that cost prior to quoting a price. We examine the implications of this uncertainty using two experimental audit markets. First, we examine a simple setting where auditors determine only audit price. Next, we examine an enriched setting that incorporates theoretically important features of the audit market consistent with prior experimental studies. Auditors learn to avoid the winner's curse with audit pricing experience in the simple market but this learning effect is hindered in the enriched market. Further, auditors in the enriched market reduce audit effort when they fall prey to the winner's curse. Our evidence suggests that uncertainty in cost generates low balling due to the winner's curse, and this source of low balling poses a threat to audit quality.

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