Dressing for the Occasion? Audit Quality in the Presence of Competition for New Clients

This paper investigates the impact of increased audit market competition on audit quality and auditor choice. I develop a model comprising two auditors who compete for a new client by choosing the audit quality for their respective existing clients. I identify factors that influence auditor quality decisions as well as the behavior of clients, who potentially manipulate their reports. Auditors are tempted to alter audit quality because they are eager to appear desirable from a new client's perspective. Interestingly, while recipients of the audited report adjust their conjectures about audit quality, there are conditions under which auditors lower quality to increase the likelihood of being hired. This effect provides an opportunity for existing clients to manipulate their reports without being detected. The analysis extends the existing literature by describing a new approach to modeling the auditors' motivation to signal reputation for certain behavior