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A defective auditing market that makes ‘lemons’ of us all

https://www.ft.com/content/fddde450-2521-11e8-b27e-cc62a39d57a0

This article covers the market for audit services and how it encompasses the “lemon” problem. A report from the International Forum of Independent Audit Regulators showed evidence that there were serious problems with 40% of the audits inspected that year. With most markets, if 40% of the goods sampled are defective, it usually isn’t a well-functioning market. The audit market, however, is different because customers(companies) must be audited(obligated to buy the product). There is also an intermediary who chooses the product for the customer and is not the company itself.

The article notes that there is not much of an advantage to compete on audit quality because that could expose vulnerabilities in a company. Big auditing companies such as KPMG and Deloitte have evaded liability by creating generic assessments of their clients’ financial standings. This is unlike the lemon model we learned in class because the client companies(buyers) of auditing services actually want the “lemon,” if it means it will be beneficial to the company. This allows the “lemon” auditing companies to be very successful, but breaking these large audit firms up will not fix the lemon problem. Buyers would have to demand higher standards for audits as well as be ready to pay for them. Auditors would then have to decide what their audits should really show about a company. In contrast to what we learned in class, sellers would want to keep selling “lemons” to buyers, and these lemons actually are the higher quality goods(even though they are in actuality a lower quality good).

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