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Evolution Vs Enforced Standards

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Field study of unregulated market for certification of baseball cards ... Prospective sellers of sports cards can hire a certification agency to grade and ... – PowerPoint PPT presentation

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Title: Evolution Vs Enforced Standards


1
Regulation, Competition and Independence in a
Certification Society Financial Reports vs.
Baseball Cards
Karim Jamal and Shyam Sunder National Taiwan
University November 22, 2006
2
Summary
  • Examination of audit certification in the broader
    context of certification activities in the
    economy
  • Extent and nature of certification services
  • Ubiquity of certification and conflicts of
    interest
  • Fineness of certification reports (2-100)
  • Field study of unregulated market for
    certification of baseball cards
  • Twenty three Certification firms
  • Market values Cross Sellers and strict grading
    services
  • Implications for auditing

3
Regulatory Attempts to Improve Auditing
  • Seven decades of regulation under the SEC
    regulation cannot prevent audit failure
  • Major changes in regulation in 2002 (SOX) to
    promote auditor independence (and Quality ?)
  • Controversy over whether these reforms improve
    auditing (Kinney et al., 2004)

4
Extent of Certification Services
  • In 1996, US Government documented 93,000 national
    standards developed by 80 government and 604
    private agencies (Jamal and Sunder 2006)
  • National and international standards cover
    virtually all aspects of the economy (Jamal and
    Sunder 2006)
  • To what extent are standards accompanied by
    availability of services to certify compliance?

5
The Audit Society
  • Audit explosion in society (Power 1994)
    education, healthcare, government supported
    activities
  • Demand for audit fueled by political demands for
    accountability and control (Power 1999)
  • U.S. audit firms attempted to expand and re-label
    their assurance services into other sectors of
    the economy in the 1990s (Elliott 1998)
  • Retail customer as the new client for services
  • Audit firms failed in attempt to expand into
    e-commerce assurance market could not compete
    with the business models of BBB Online and TRUSTe
    (Jamal, Maier and Sunder 2003)
  • Attempt to empirically assess the extent of
    availability of certification services

6
Sample Selection
  • Selected a sample of 817 items sold online and
    offline during June 12-July 25, 2004
  • 400 items from eBay.com (online)
  • 358 items from BLS Producer Price Index
  • 59 items from BLS Consumer Price Index

7
Types of Certification Services
  • Expert opinion about compliance with formal
    written standards (91)
  • Expert opinion in absence of formal standards
    (7)
  • Ratings given by lay people (no standards) 1
  • Popularity/activity meters (best-seller lists for
    books, music, films, TV, etc.) 0.5
  • Total 99.5 have some kind of certificate
  • All four kinds of certification available for 40

8
Table 1 Certification Services for Products Sold
Online and Offline in the US
9
Extent of Certification
  • Results suggest support for Powers
    characterization of ours as a audit society
  • AICPA failed in its attempt to fill what they
    thought were empty spaces in the market for
    assurance services
  • Although Power (1994) focused his study on the
    public sector, the certification is also
    ubiquitous in the private good space
  • Demand for certification for private goods must
    be driven by broader economic forces, not just
    politics

10
Data Obtained from One Official Partner of eBay
(XYZ)
  • 128 experts
  • Offer opinions on 1,850 separate items
  • 9.95 fee for basic service
  • 29.95 for enhanced service
  • Experts do not follow any written standards
  • Opinions do not reference any written standards
  • Provides descriptions of experts (accreditation
    by professional institutes, education, related
    business, relevant experience) two examples

11
Self-Assessment of XYZs Experts
  • 128 experts as of July 12, 2004
  • 39 had formal accreditation from a professional
    body
  • 25 formal relevant educational credentials
  • 79 ran a business in the products for which they
    provided certification
  • Only 9 reported themselves to be hobbyists

12
Implications for Auditing
  • Conflict of interest appears to be pervasive
    (norm) in certification services in general
    (79), not confined to auditing
  • Unacceptability of consulting services to audit
    clients in a regulated market (Francis 2004)
    contrasts sharply with this data from unregulated
    domains

13
Fineness of Ratings/Certification
  • Auditor reports are essentially pass/fail
  • Auditor gains a broad understanding of the
    quality of internal controls, governance,
    accounting policies, estimates, and disclosure
  • The coarse pass/fail grading does not attempt to
    convey this detailed information to the client
  • Shouldnt a finer report be more informative to
    users of the audit report?

14
Economic Theory
  • Dubey and Geanakoplos (2005) In general, an
    optimal grading scheme should have an
    intermediate level of fineness
  • Coarse reports have less information and do not
    motivate the reporting agent to exert more effort
  • Fine reports magnify the consequences of
    measurement errors
  • Intermediate grading scale may be optimal
  • Grading scheme should create a small elite
  • Absolute grading schemes dominate relative

15
Data on the Fineness of Government Standards
  • Visited websites of 80 departments of the federal
    government that set standards (Toth 1996)
  • We able to access standards of 64 (80) of these
    agencies
  • 53/64 (83) set minimum requirements (pass/fail
    only)
  • 11/64 (17) use finer grading (e.g., AAA beef)
  • DG Most federal agencies use absolute standards,
    but do not set elite grades or use intermediate
    fineness scales (FDA is an exception)

16
Greater Variability in Fineness of Scales in
Private Standards
  • Pass/fail (e.g., UL)
  • Multiple seals (TRUSTe for e-commerce privacy,
    Jamal, Maier, Sunder 2003, 2005)
  • 10-100 point rating scales (baseball cards,
    Consumer Reports on cars)
  • Often characterized by competition among rival
    standards and scales
  • Rating scales as a dimension of competition among
    services (Jin, Cato and List 2004)

17
Market for Baseball Card Certification Services
  • Jin, Cato and List (2004)
  • Dominant player is PSA 1991, 10-point scale with
    1 point inc., not graded on curve, 10 cards get
    10 (no super elite grade)
  • BGS 1999, 10-point scale with ½ point inc.,
    numerical and qualitative labels (mint),
    subgrades for corners, centering, surface, edges
    0.1 cards get 10, publishes grade distribution
    on-line three brands of service (BVG, BGS, and
    BCCG)
  • SGC 1999, smaller market share, 100-point scale
    (confusion, conversion table to 10-point scale)
  • 20 other smaller players (Table 3), largely
    consistent with DG predictions (no curve,
    intermediate fineness, super elite)

18
Table 3 Sports Card Grading Services (Summer
2004)
19
Comparison with the Market for Audit Services
  • Only binary pass/fail reports, little further
    detail permitted
  • If the purpose of SOX is to convey information
    about internal controls, will switch from
    pass/fail to graded report on IC, governance,
    quality of accounting estimates and accounting
    policy choices give better value to investors?
  • The current system suppresses the detailed
    knowledge gained by the auditor more consistent
    with govt. not private markets

20
Value of Certification in Sports Card Market
  • Prospective sellers of sports cards can hire a
    certification agency to grade and certify their
    merchandise before selling
  • Independence and audit quality are difficult to
    observe in the audit market
  • Baseball card market includes pure and
    multi-service certifiers, allows a cleaner
    measure of audit quality in grading strictness,
    observation of an unregulated market and
    dimensions of competition (e.g., value pricing,
    computer grading, multiple experts grading the
    same card, letting customers choose their own
    grade)
  • Anxiety about race-to-the-bottom and independence
    in accounting (Dye and Sunder 2001)

21
Data for Assessing the Value of Certification
Services
  • 321,045 cards traded on eBay during August
    19-September 3, 2004
  • Partitioned cards by decades of origin,
    single-rookie, graded-ungraded (Table 4)
  • Randomly selected 1,000 rookie and 1,000 singles
    cards from graded cards
  • Market shares of six major firms (Table 5) in the
    sample of graded cards (PSA 78 in singles, 39
    rookie BGS 6 singles, 34 rookie) Tables 5A, B

22
Table 4 Baseball Card Certification
Services (Baseball Cards Traded on eBay,
N321,045) Singles (272,399 cards)
Rookies (48,646 cards)
23
Assessing Strictness of Grading
  • Jin, Cato and List (2005) gave the same 212 cards
    to PSA, BGS and SGC online and to three offline
    dealers
  • Average scores 8.5 for BGS and two dealers 8.7
    for PSA and one dealer, and 8.9 for SGC (BGS
    tighter cut-offs, precise) Table 5C
  • Tables 5A and B empirical frequencies in our
    sample (self-selection bias) BVGs premium
    service stands out (GAI, SGC)
  • Beckets value brand (BCCG) is lower priced, also
    has relaxed standards
  • GEM gives the top grade of 10 to 73 percent of
    the singles cards
  • In rookie Table 5B roughly similar results
  • Is the market able to adjust itself for
    differences in grading?

24
(No Transcript)
25
Table 5A Frequency of Grades Given by 3rd
Party Certification Services (For a Sample of
1,000 Graded Single Baseball Cards)
26
Table 5A Frequency of Grades Given by 3rd
Party Certification Services (For a Sample of
1,000 Graded Single Baseball Cards)
27
Pricing and Value of Baseball Card Certification
Services
  • PSA charged a 99 membership fee (dropped
    recently)
  • Table 3 Price varies (2-50), extra for faster
    turnaround
  • For each graded card in the sample, we located an
    ungraded card matched by player, maker, year of
    issue, single-rookie
  • For unrated cards, we gathered price estimates
    from Beckett Baseball Card Monthly Guide (August
    2004, Issue 234 online)
  • For rated cards, we recorded player, year, maker,
    grader, grade, buyer reputation, seller
    reputation, number of bids, and selling price
  • Table 6 Gross and net returns on baseball card
    grading services provided by six major service
    providers

28
Table 6 Average Returns to Grading of Rookie
Cards (by Grader and Decade of Issue)
29
Returns to Audit
30
Table 7 Regression Analysis Ri ?1 ?1Yeari
?2Gradei ?3GPSAi ?4GBGSi ?5GBecketti
?6GGAIi ?7GGEMi ?8GSGCi ei Regression
(990)df, R2 0.1747, p lt 0.001. (Adjusted R2
0.168)
p lt0.001 p lt 0.01 p lt 0.05
31
Regression Analysis
  • Table 7 Year, grade and identity of grader have
    a significant effect on net return from the
    certification service
  • Certification service is more valuable for older
    cards (selection effect?)
  • The returns are ranked by strictness of grading
    scales, negative for the lenient graders
  • Easy grade of 10 from GEM does no good for the
    value of the card
  • No race to the bottom
  • Beckett able to provide different brands of
    service, and market is able to differentiate
    among them without getting confused

32
Back to Auditing
  • Regulatory objectives of auditing (quality of
    certification, independence, etc.)
  • In baseball card market 17/23 offer only
    certification services but six (including all
    major) players offer related services (pricing
    guides, dealers, magazines, shows) as well as
    handle other collectibles
  • Cross-sellers dominate the market and are able to
    collect premium price for their service, yielding
    positive net returns to their clients
  • Independence appears to be neither necessary nor
    sufficient condition for high quality service in
    this certification market
  • Why?

33
Skepticism about Deregulation
  • Will a deregulated market for auditing function
    properly (race to the bottom, Dye and Sunder)?
  • Recent policy changes (PCAOB) have gone in the
    other direction
  • Lenient graders generate negative returns to
    their clients
  • Jamal, Maier and Sunder (2003) on market for
    privacy seals in e-commerce dominated by higher
    quality
  • Does cross-selling of services promote or inhibit
    grade inflation?
  • What are the real reasons for poor enforcement of
    GAAP by audit firms?

34
Concluding Remarks
  • Evidence on ubiquity of certification
  • Certification by government agencies is mostly
    binary (pass/fail)
  • Private certification has finer scale
  • Field study of baseball card grading market
  • Dominated by cross sellers (conflict of interest)
  • Multiple dimensions of competition
  • No race to the bottom

35
Open Questions
  • Will the tough auditors win or lose?
  • Are Independent auditors tough auditors?
  • Precision of grading Significant? Should
    auditors issue more nuanced reports?
  • Does it pay to get audited (vs. reputation,
    warranty and disclosure)
  • Will de-regulated audit market lead to quality
    differentiation?
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