Concentration after a Contracting Experiment: Mandatory Audit Firm Rotation

Abstract: Policymakers occasionally intervene to reduce concentration in a market; the EU’s 2014 mandatory audit firm rotation (MFR) regulation is a prominent example. One objective of MFR was to erode the Big 4’s dominance by forcing periodic auditor switches for public companies. However, heterogeneous firm-level demand for auditor-specific expertise may cause companies to rotate within rather than away from the Big 4, leaving overall concentration unchanged. We formalize this intuition in a theoretical matching model whereby large clients re-sort to the Big 4 under forced rotation, so that mandatory switching churns engagements within the dominant tier rather than dispersing them. We test the prediction by evaluating the EU regulatory change as a quasi-experiment, using the US—which did not adopt it—as a control. We find, within tight bounds, that MFR did not reduce the fee-weighted market share of the Big 4: the policymaker’s concentration reduction objective was not achieved. The flow decomposition of auditor switches shows that 95.4% of the post-MFR fee volume that rotates does so without crossing the Big 4 boundary, with the firms that do cross being small and fee-immaterial. MFR thus redirects rather than removes concentration.