Is mandated independence necessary for audit quality?

Karim Jamal

⇑

, Shyam Sunder

b,1

School of Business, University of Alberta, Edmonton, Alberta, Canada T6G 2R6

School of Management, Yale University, P.O. Box 208200, 135 Prospect St., New Haven, CT 06520-8200, USA

article info

abstract

Independence (in fact as well as in appearance) is widely thought to be necessary for the

quality of audits, and audit quality is often equated with independence. Private incentives

to demand (and supply) independent certiﬁcation of ﬁnancial statements are thought to be

insufﬁcient, thus the need to mandate independence through regulation. This study pre-

sents data from a ﬁeld experiment on the unregulated market for certiﬁcation of baseball

cards to assess the role of independence vis-à-vis other auditor attributes such as compe-

tence, price, and service on audit quality. In our ﬁeld experiment, we examine prices of

baseball cards sold on eBay with or without third party certiﬁcation. In addition, the cer-

tiﬁer was either independent or deeply immersed in providing other services to market

participants. We ﬁnd that market participants pay a signiﬁcant premium for certiﬁed cards.

Certiﬁers who are deeply immersed (and therefore apparently less independent) also pro-

vide higher quality service in the form of being stricter graders, command larger price pre-

miums, and dominate in market share. Implications for independence and audit quality are

discussed.

The signiﬁcance of independence in the work of the

independent auditor is so well established that little

justiﬁcation is needed to establish this concept as one

of the cornerstones in any structure of auditing theory.

Mautz and Sharaf, The Philosophy of Auditing,

1961

Introduction

Two key features of the ﬁnancial reporting system are

that an audit is mandated for publicly traded companies,

and that it must be conducted by accountants who are inde-

pendent in fact (i.e., have an objective state of mind) as well

as in appearance. Both these dimensions of independence

are assumed to be necessary for attaining audit quality

(DeAngelo, 1981; Mautz & Sharaf, 1961). The current struc-

ture of the audit profession, according to some observers,

undermines audit quality. For example, managers of clients

hiring their own auditors raise concern about the indepen-

dence of the latter (Dontah, Ronen, & Sarath, 2004; Fiolleau,

Hoang, Jamal, & Sunder, 2011; Mayhew & Pike, 2004). In

addition, the provision of non-audit services undermines

perceptions of independence and raises questions about

impairment of objectivity (Dopuch & King, 1991). In this pa-

per we examine functioning of the online market for base-

ball cards for the effect of the sale of other services by

private third party certiﬁers. We provide some evidence,

albeit indirect, on the applicability of the important founda-

tional assumption about certiﬁer independence.

Promotion of independence of auditors, primarily by

prohibiting or restricting their ability to provide advisory

services to their audit clients, has been a key regulatory

instrument for improving ﬁnancial reporting (Dopuch &

King, 1991). At least since Mautz and Sharaf (1961), a cen-

tral belief of audit regulators and educators has been that

users of certiﬁcation services should perceive value in

receiving a certiﬁcation report from someone who has

the motive to provide good quality service, or at least, does

doi:10.1016/j.aos.2011.03.001

⇑

Corresponding author. Tel.: +1 780 492 5829; fax: +1 780 492 3325.

E-mail addresses: [email protected] (K. Jamal), shyam.sunder@

yale.edu (S. Sunder).

Tel.: +1 203 432 6160; fax: +1 203 432 6974.

Accounting, Organizations and Society 36 (2011) 284–292

Contents lists available at ScienceDirect

Accounting, Organizations and Society

journal homepage: www.elsevier.com/locate/aos

not have a conﬂict of interest that may keep him/her from

providing good quality service. However, users may also

value other dimensions of auditing such as expertise, rep-

utation, price, or service quality (Weber, Willenborg, &

Zhangm, 2008). Most debate in the audit literature has fo-

cused largely on the fact and perception of independence,

with little evidence collected regarding the possibility of

markets trading off independence, experience, compe-

tence, prices and other features of the service. Understand-

ing of such trade-offs is important for public policy on

audit reforms (e.g., DeFond, 2010).

Markets for certiﬁcation services may value not only

independence, but also other characteristics that may

weaken certiﬁers’ independence (such as better informa-

tion derived from having the auditor immersed in client

activities). In such circumstances, markets may not place

the highest value on the corner solution in which indepen-

dence of the auditor is maximized at the expense of other

attributes (Klein, 1997). Investor interests may be served

better by an appropriate balance among their preferences

for various characteristics. We need not assume, a priori,

that this balance will necessarily be achieved by primacy

of independence over all other considerations (see also

Power, 2003).

Assessing the necessity of independence for audit qual-

ity using archival data is difﬁcult. Widespread belief in

centrality of independence, and mandate for independence

in all developed economies, makes it difﬁcult to conduct

comparisons across jurisdictions. Prior approaches to

assessing independence involved examination of pre-

1930s audits of public ﬁrms (e.g., Chow, 1982; Merino,

Mayper, & Sriram, 1994), and contemporary audits of pri-

vately-held ﬁrms (e.g., Chaney, Jeter, & Shivakumar,

2004). Since certiﬁcation activity is pervasive in modern

economies (Power, 1994), in this paper we adopt an ap-

proach used by Jamal, Maier, and Sunder (2003, 2005)

whereby we look outside accounting markets to draw

inferences about what might happen if some key auditing

regulations were relaxed or repealed.

We study the online baseball card certiﬁcation market

to assess the value of independence. In this market, pro-

spective owners/sellers can hire a certiﬁer to grade and

certify the authenticity of their cards. Baseball cards differ

from ﬁnancial reports in many respects. One difference, for

example, is in the process of post-audit negotiation and

adjustments between the client and the auditor that leads

to the audited ﬁnancial report as a joint product of the two

(Gibbins, McCracken, & Salterio, 2010). There is no negoti-

ation process in the market for certifying baseball cards.

Yet, the certiﬁcation market for baseball cards share some

common elements with ﬁnancial statement auditing that

may allow us to gain some useful insights into functioning

of such markets through cross-comparisons.

Care is necessary in drawing cross-market implications

for auditing. Baseball cards are physical objects of substan-

tive interest and the audit process does not change the

baseball card, while ﬁnancial reports are symbols negoti-

ated during the audit process, representing complex enti-

ties of substantive interest to buyers of certiﬁcation

services. In both cases, buyers are willing to pay for others’

expertise, in presence of varying extent of standards as

point of reference for certiﬁcation. In both cases, buyers

rely on the knowledge and reputation of the certiﬁers

who compete for fee revenues (Klein, 1997). In both cases,

individual certiﬁers choose the portfolio of certiﬁcation as

well as other services they may offer to their customers.

Although auditing of publicly-held ﬁrms is mandated by

the securities laws, there is evidence that the demand for

independent audits of public ﬁrms, originating in agency

considerations pre-dated the regulatory mandate (Chow,

1982).

Issuers of securities hire auditors to enhance the credi-

bility of their ﬁnancial reports. Empirical examination of

the consequences of independence for audit quality is

complicated by the difﬁculty of observing and controlling

independence, competence and other service characteris-

tics. In the baseball card certiﬁcation market, we have an

opportunity to observe pure auditors (who only certify

baseball cards) as well as cross-sellers who sell a range of

additional related services. Each certiﬁer posts a written

set of proprietary standards and a schedule of prices,

including premiums for faster service. Competition among

rating agencies involves both setting of standards as well

as provision of certiﬁcation services. Providing two addi-

tional services (creating pricing guides, and acting as a

dealer in the market) create potential for conﬂict of inter-

est for certiﬁers. The baseball card certiﬁcation mar-

ket allows us to observe directly a cleaner measure of

audit quality (grading strictness and test–retest process

consistency) than is usually available in archival studies

of auditing. The baseball card market also provides an

interesting opportunity to observe how unregulated certi-

ﬁers may try to distinguish themselves by adding new ser-

vice features such as value pricing (e.g., TFA), computer

grading (CTA), having two experts grade each card (PRO),

and allowing each customer to choose their own grade

(MINT) (see Table 1).

The potential for a race to the bottom among certiﬁers

who lower their quality when competing for clients is a fre-

quent theme in accounting (see Dye and Sunder (2001) for a

discussion of such fears). It would be interesting to observe

how an unregulated market for certiﬁcation services reacts

to independence, potential for conﬂict of interest, grading

strictness (or leniency) and other service differentials.

There are many differences between the regulated mar-

ket for audit services and unregulated certiﬁcation markets

for other goods and services. The communication and

negotiation process that precedes the issuance of the audit

certiﬁcate, the presence of a diverse group of stakeholders

interested in the audit report, and the opacity of audit

quality, are some obvious differences. While no two mar-

kets are exactly alike, cross-market comparisons might

help us better understand the characteristics and sources

of variations in certiﬁcation services, especially the de-

mand for certiﬁcation in the absence of independent certi-

ﬁers (Jamal et al., 2003, 2005; Klein, 1997).

We report results of a ﬁeld study of baseball cards sold

on eBay with (and without) third party certiﬁcation. In

Note that the comparison we use here is between the two markets for

certiﬁcation services (for ﬁnancial reports and baseball cards) and not

between the ﬁnancial reports and baseball cards themselves.

K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

285

addition, certiﬁers range from completely independent to

providing other services which create a potential for con-

ﬂict of interest. Our results indicate that in the baseball

card certiﬁcation market, strict graders are more valued

than lenient graders. There is no race to the bottom for cer-

tiﬁcation quality. Certiﬁcation agencies that cross-sell re-

lated services provide better audit quality (i.e., they are

stricter graders), than independent certiﬁcation agencies,

and have the largest market share. These ﬁndings extend

our understanding of the economic forces underlying the

formation of trust and audit quality in private certiﬁcation

markets.

Baseball card rating standards and potential conﬂict of

interest

There exists a large ofﬂine and online market for buying

and selling of baseball cards. Sports trading cards were ﬁrst

produced and offered in the 1880s by tobacco manufactur-

ers who would include them as a free accompaniment to

purchasers of their products. Gum and candy makers soon

employed the same marketing strategy. Over time, the pro-

fessional sports leagues began to appreciate the economic

value of this activity and exerted control over the number

and type of cards produced. This ofﬂine (hobby) activity be-

came a serious economic activity, especially after the intro-

duction of internet auctions by eBay in 1998. Interest in

baseball card trading as an economic activity rivaling other

antiques and paintings was fueled by a Honus Wagner T206

Sweet Caporal Cigarette baseball trading card that was auc-

tioned off for a staggering $1,100,000 on eBay in July of

2000.

In the ofﬂine market, a prospective buyer would visit a

trading card shop and physically inspect the condition of a

card before purchase. This ofﬂine market continues today,

and many card trading shops are run by dealers who buy

and sell cards for a variety of sports and TV show based ac-

tion ﬁgures. The ofﬂine market also created demand for a

pricing guide, magazines, card shows and other baseball

related activities. With the advent of the internet, however,

a demand arose for a third party certiﬁcation service so

Table 1

Sports Card Grading Services.

Name Year

founded

Scale

categories

grading

cost

Guarantee Cross-

seller

Feature

1. Accugrade (ASA) 1988 13 $5–15 No No Invented 10-point scale + ﬁrst

online rating agency

2. Professional sports authentication (PSA) 1991 10 $9–50 Yes Yes Membership fee ($99  get six

cards graded free) + largest

market share

3. KSA 1996 14 $12–19 No No Canadian

4. American authentication (AAI) 1996 10 $12–22 No No Five card minimum per order

5. Finest grading (FGS) 1997 14 $5–25 No Yes Value pricing card shows

6. Map industries 1998 14 $8 No No Free shipping

7. Beckett grading service (BGS) 1999 19 $8–25 Yes Yes Price guide + provide sub-grades

for centering, corners, edges, and

surface

Vintage grading (BVG) $9–26

Collectors club (BCCG) $5

8. Sportscard guaranty (SGC) 1999 18 $7–50 No Yes Started with 100-point scale

9. The ﬁnal authority (TFA) 1999 19 $5–13 Yes No Value pricing

10. Collection monster (CM) 1999 19 $10 No Yes Government grading

11. Advanced grading (AGS) 2000 11 $9–25 No No Top view holders

12. Mint grading services 2000 18 $6–20 Yes No Customer chooses grade. If MGS

disagrees, pay $1 only

13. CTA grading experts 2000 11 $10–30 No No Computer grading

14. Bear stats grading (BSGS) 2002 14 $10–20 No No Value pricing

15. Global authentication (GAI) 2002 19 $6–20 No Yes Former PSA experts + dealer

focused

16. Pro sports grading (PRO) – 22 $9–50 No No Two experts grade each card

17. Professional grading service (PGS) – 19 $5–35 Yes No Help to post on eBay

18. World class grading (WCG) – 20 $5–20 Yes No Value pricing

19. Champs grading service (CGS) – 10 $2–3 Yes No Racing specialists

20. Grade tech – 21 $14–50 No No Computerized grading

21. Premier grading (PGI) – 20 $6–20 No No Value

22. Gem trading – 9 $8–15 No No Value

Gem elite $12–19

23. Sports memorabilia authenticator (SMA) – 19 $6–8 No No Value/older cards

In summer, 2004, there were 23 active sports card grading services online. We visited each website to identify the year of formation, and the rating scales.

They use a 10-point scale with 1 or ½ point increments; some use + s or have discontinuities in their scale (e.g., do not award some grades such as 9.5).

We also recorded the grading fee they charge for the slowest service offered as well as the fastest service (customers also have to pay shipping and

insurance costs to separate companies). Under grading cost (e.g., $5–15), the ﬁrst number is the cost of a normal grading service, and the second numberis

the cost of getting an expedited grading service.

Some companies offer a guarantee to return graded cards within a speciﬁed time period. Some companies have ofﬂine activities such as card shows where

sports cards can be bought or sold and graded at a physical location, magazines, price guides, provide their own auction sites and a range of other services.

286 K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

that buyers and sellers could trade cards at a distance,

without the buyer being able to physically inspect the card.

This demand led to creation of private third party certiﬁca-

tion services for baseball cards. For a fee, a prospective sell-

er can mail his card to a certiﬁcation agency. The agency

grades the card and returns it sealed in a tamper proof

package. The card can then be sold as a certiﬁed card. All

certiﬁcation agencies post a price schedule, a grading

scheme and offer a variety of features such as fast delivery

and computer grading. Most graders use a 10 point grading

scheme and use qualitative labels such as Mint condition.

Internet trading has also made it easier for preparers and

prospective traders to develop and/or purchase a baseball

card pricing guide. For example, The Beckett pricing guide

collects data from dealers (for ofﬂine sales) and monitors

online sales for both graded and ungraded cards, and re-

ports a high, average and low selling price for a vast data-

base of cards. The provision of pricing guides, and acting as

a dealer (as well as certiﬁer) create potential conﬂict of

interest for baseball card certiﬁers.

Professional Sports Authenticator (PSA) started provid-

ing online grading service in 1991 and currently dominates

the market in volume. PSA dominates the market for single

and rookie baseball cards as well as basketball and football

cards. PSA uses its dominant position to collect a $99 mem-

bership fee for access to its rating service.

PSA offers a

magazine and a price guide, and runs card shows where col-

lectors can meet certiﬁers, get their cards graded on site, and

talk to PSA staff. PSA is a part of publicly-traded Collectors

Universe (NASDAQ: CLTC) which offers rating services for

coins, stamps, autographs and music. PSA rates cards on a

10-point scale at 1 point interval (e.g., 8, 9, 10). Each point

on the scale also has a qualitative label (e.g., 10 = mint).

PSA does not use a curve to grade, and does not create a

super elite grade (the top grade of 10 is given to about

10% of cards graded).

Starting in 1999, the privately held Beckett Grading Ser-

vice (BGS) has gained a signiﬁcant share of the market and

emerged as PSA’s main competitor. In addition to rating

cards, BGS offers a magazine, price guide (which provides

estimates of prices for baseball cards graded by BGS as well

as by its competitors, and for ungraded cards), and card

shows. BGS rates cards for racing, several sports (baseball,

football, and basketball), comic books, and action ﬁgures

(such as Pokémon and Digimon).

BGS distinguishes itself from PSA in three ways: First, it

uses a 10-point scale with 0.5 point increments, and pro-

vides sub-grades for centering, corners, edges and surfaces.

Second, it uses a stricter grading standard, giving the high-

est grade of 10 to less than 0.1% of the cards it grades PSA

also issues a population report but a user has to pay a $4.95

fee to access the report. The population report is also bun-

dled with PSA’s pricing guide, which only provides prices

of cards graded by PSA. BGS builds market awareness of

its grading strictness by periodically posting the distribu-

tion of grades issued by BGS (a BGS distribution is available

to its customers at http://www.beckett.com/grading/pop-

report.asp?action=summary). Third, Beckett caters to dif-

ferent market segments by offering three brands of

service at different prices: a standard BGS service, an elite

vintage service (BVG), and a value product for more price

conscious customers (BCCG). The attempt by Beckett to

create multiple brands for different clienteles has no direct

parallel in auditing.

The third major online certiﬁer of baseball cards, far be-

hind the two leaders, is Sportscard Guaranty (SGC). It en-

tered this market in 1999 and attempted to distinguish

itself by introducing a 100-point scale which apparently

created some market confusion. SGC started providing a

nonlinear conversion table to translate its 100-point scores

into a 10-point score and the associated qualitative labels.

SGC does not provide additional sub-grades.

Twenty other baseball card certiﬁcation services vie for

customers (see Table 1) using the 10-point scale in incre-

ments of 1 or 0.5, some adding extra grade categories (e.g.

pristine) allowing some 10–22 possible grades. None of

these twenty sites uses a grading curve. Each of these certi-

ﬁers tries to distinguish itself by providing a guarantee,

helps the seller post their card on eBay, offers computer

grading, or even lets the customers specify the grade they

want (i.e., the customer only pays a fee if the certiﬁer agrees

to issue the grade requested by the customer).

Method

To assess the value of certiﬁcation services, we collected

a matched pair data set of baseball cards traded on eBay.

We selected 321,045 baseball cards traded on eBay during

August 19–September 3, 2004. We partitioned the cards by

the decade of issue (e.g., 1930s, 1940s ... 2000s, etc.), sin-

gle or rookie, and whether they had been graded. Of the

321,045 cards in our sample, 272,399 (85%) were singles,

of which 31,778 (11%) had been graded. Of the 48,646 roo-

kie cards, 12,290 (25%) had been graded (see Table 2). We

drew a stratiﬁed (by decade of issue) random sample of

1000 graded rookie cards for analysis.

Market share

Table 3A shows the estimates of market shares of six

ﬁrms in the rookie card market on the basis of our strati-

ﬁed sample of 1000 graded cards traded. PSA and the three

levels of services provided by Beckett represent approxi-

mately 35% market share each, while GEM represents

16% market share.

Fineness

The grading schemes used 9–22 rating categories on a

10-point scale with 1 or ½ point increments (with occa-

During a return visit to the PSA website in May 2010, we found that the

membership fee had been made optional. Membership grants certain

privileges (free card grading, magazine) but is no longer required to access

the PSA grading service.

However, in Fiolleau et al. (2011) ﬁeld study of an audit engagement,

they observed that one of the Big 4 audit ﬁrms submitted three simulta-

neous bids for the same engagement. The three bids varied with respe ct to

pricing and the range and level of audit services offered to the client.

We focus on rookie cards rather than singles because rookie cards are of

higher value, they are more likely to be certiﬁed, and there are more

certiﬁcation agencies who provide services for rating rookie cards. The

singles card market is dominated by PSA with a 78% singles market share; it

has only 36% share in the rookie card market.

K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

287

sional variations such as a plus sign or a ‘‘pristine’’ grade at

the top of ‘‘mint’’, see Table 1). One grader (SGC) uses a

100-point scale, and provides a (non-linear) table to con-

vert its grades onto a 10-point scale.

Strictness

We use two bases for assessing the strictness of grading.

First, Jin, Kato, and List (2008) conducted a ﬁeld experi-

ment to assess consistency and grading strictness of base-

ball card certiﬁers. Jin et al. (2008) gave the same 212

baseball cards to three online graders (PSA, BGS and

SGC), and to three ofﬂine dealers. The average scores were

8.5 for BGS and two ofﬂine dealers, 8.7 for PSA and one off-

line dealer, and 8.9 for SGC. They concluded that BGS rat-

ings used a tighter cut-off point and were more precise

(see Table 3B based on Jin et al.’s Table 2). Jin et al. classi-

Table 2

Baseball card certiﬁcation services (baseball cards traded on eBay, N = 321,045; 272,399 singles and 48,646 rookie cards).

Issue date Graded UnGraded Total %Graded Graded UnGraded Total %Graded

Pre1930s 1935 2933 4868 40 – – – –

1930s 1376 1689 3065 45 – – – –

1940s 417 1448 1865 22 20 218 238 8

1950s 6160 22,869 29,029 21 59 606 665 9

1960s 7291 28,007 35,298 21 161 750 911 18

1970s 6858 14,171 21,029 33 303 1221 1524 20

1980s 3692 8533 12,225 30 5470 6378 11,848 46

1990s 2693 25,163 27,856 10 3669 9578 13,247 28

2000s 1356 135,808 137,164 1 2608 17,605 20,213 13

Total 31,778 240,621 272,399 11 12,290 36,356 48,646 25

During August 19–September 3, 2004 a total of 321,045 baseball cards were traded on eBay. We counted the cards which had been graded by a 3rd party

certiﬁcation service. The data in the table show the number (and percent) of graded cards by decade in which they were issued. Data for single and rookie

cards are shown separately to highlight the differences in the propensity to purchase grading services for different types of cards. eBay provides a

breakdown by date of issue for singles cards from pre-1930s and 1930s, but not for rookie cards.

Table 3A

Frequency of grades given by 3rd party certiﬁcation services (for a sample of 1000 graded rookie baseball Cards).

3rd Party grader Market share % Grade Total Average score

10 9.5 9.0 8.5 8.0 7.5 7.0 6.0 5.0 <5

PSA 36.8 105 0 159 0 80 0 17 4 2 1 368 8.9

BGS 22.7 1 85 73 37 13 14 1 1 1 1 227 8.9

BCCG 10.4 87 0 16 0 0 0 0 1 0 0 104 9.8

GEM 11.6 116 0 0 0 0 0 0 0 0 0 116 10.0

SGC 2.9 4 0 13 6 4 1 1 0 0 0 29 8.8

GAI 2.3 2 9 8 2 1 0 0 1 0 0 23 9.1

Other 17 Certiﬁers 13.3 91 2 20 10 2 1 0 1 3 3 133 9.4

Total 100% 406 96 289 55 100 16 19 8 6 5 1000

The data in the table show the market share of 23 baseball card certiﬁcation services and the grades received by cards in our sample. The leading 3rd party

certiﬁcation provider (PSA) issued a grade of 10–4% of the cards (105/368). In contrast, the second certiﬁcation provider (BGS) issued a grade of 10 only once

out of 227 cards, but tended to offer 9.5 more frequently (85/227 = 37%). The average grade of cards certiﬁed by both PSA and BGS were both 8.9.

Table 3B

Frequency of grades given by 3rd party certiﬁcation services in ﬁeld experiment. Source: Jin et al. (2008), Table 2.

3rd Party grader Total no. of cards Grade Average score

10 9.5 9 8.5 8 7.5 7 6.5 6 5.5 5 4.5 4

PSA 212 11 134 66 1 0 0 0 8.7

BGS 212 0 0 40 124 43 3 2 0 0 0 0 0 0 8.5

SGC 212 13 134 49 11 3 2 0 0 0 0 8.9

Kevin 212 0 1 40 129 37 4 1 0 0 0 0 0 0 8.5

Rick 212 0 11 57 92 45 3 2 0 1 0 0 0 1 8.5

Rodney 212 0 1 120 62 25 2 0 0 2 0 0 0 0 8.7

Total 24 13 525 456 227 15 8 0 3 0 0 0 1 8.6

Jin et al. (2008) conducted a round robin ﬁeld experiment. They purchased 212 baseball cards and sent cards to three online.

Grading services (PSA, BGS and SGC) and three ofﬂine baseball card dealers (Kevin, Rick and Rodney) for grading.

Grades assigned by these six graders are reported in the table. BGS and two ofﬂine dealers (Kevin and Rick) assigned an average grade of 8.5 and were more

strict than the remaining three raters who assigned average grades of 8.7 (PSA), 8.9 (SGA) and 8.7 (Rodney).

Jin et al. (2008), test for grading strictness by computing a noise parameter for each grader (

). Difference between

of BGS versus PSA was 1.000

(p < 0.01), BGS versus SGC was 0.855 (p < 0.01), and SGC versus PSA was .145 (ns).

288 K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

ﬁed BGS as a strict grader and PSA and SGC as medium

graders. Jin et al. (2008) test for grading strictness by com-

puting a noise parameter for each grader (

). The differ-

ence between

of BGS versus. PSA was 1.000 (p < 0.01),

BGS versus. SGC was 0.855 (p < 0.01), and SGC versus.

PSA was .145 (not signiﬁcant).

Their study assessed both grading strictness (average

grade) and a process measure of audit quality (consistency

and test–retest reliability). Certiﬁcation agencies that were

stricter were also more consistent in their ratings. We use

the Jin et al. (2008) results to classify BGS as a strict grader,

and the other two (PSA, SGC) as medium graders.

For graders not covered in the Jin et al. (2008) study, we

use the average grades observed in our samples to classify

them by strictness of grading. In our sample of 1000 rookie

cards, GAI has an average rating of 9.1, which is very similar

to that of PSA (8.9), so we classify GAI as a medium grader.

Two graders, GEM (average grade of 10) and Beckett’s brand

BCCG (average grade of 9.8), are classiﬁed as lenient graders

(see Table 3A). The remaining graders have only a few

occurrences in our sample, so we do not analyze them fur-

ther and do not assign them a strictness classiﬁcation. Since

sellers self-select which cards they send to each certiﬁca-

tion service, this measure suffers from the self-selection

problem common to many archival studies. Frequency of

grades provides additional corroboration to the controlled

experiment run by Jin et al. (2008).

Pricing

The per-card certiﬁcation fee charged varies in the

range from $2–50 across the 23 graders with a higher price

for faster turnaround. Similarity of posted prices suggests

that the competition is driven primarily by non-price vari-

ables (see Table 1).

Data analysis

For each graded rookie card in our sample of 1000, we

found a matched (by player, card maker, year of issue,

rookie) un-graded card. Values of un-graded cards were

obtained from Beckett Baseball Card Monthly Guide

(August 2004, Issue #234-online).

The Beckett price guide

provides a range of price estimates for each card with high,

average, and low values. For each rated card sold on eBay,

we recorded the player, year, card maker, grader, grade re-

ceived, buyer reputation, seller reputation, number of bids,

and selling price.

Gross and net (of the cost of certiﬁcation) returns of

baseball cards rated by six major certiﬁcation service pro-

viders are shown in Table 4. All six certiﬁcation services

yield a positive gross return (selling price of a rated card

exceeds the average estimate of the value for the same

unrated card in the Beckett pricing guide). The gross return

ranges from +80% for cards certiﬁed by GEM to a return

of +264% for cards certiﬁed by BGS. These returns are an

order of magnitude higher than the reputation premi-

ums documented for Big 4 audit ﬁrms in audit pricing

studies (Ferguson, Francis, & Stokes, 2003; Francis & Yu,

2009).

Since the cost of certiﬁcation is posted by each certi-

ﬁer,

we can also examine the net return to the purchaser

of the baseball card certiﬁcation. The data in Table 4 shows

that the return net of the cost of certiﬁcation is positive for

the strict grader (46% for BGS) and one medium grader

(92% for GAI), close to zero for two medium graders (4%

for SGC, and 2% for PSA), and negative for the lenient

graders (14% for BCCG, and 23% for GEM).

To assess the relationship between the return from

grading, and various characteristics of cards and grader

identity, we estimated the following regression equation

(Table 5):

Table 4

Average returns to grading of rookie cards (by grader and decade of issue).

Rater Number

of cards

Gross

return %

Net

return %

2000 +

Gr.=10%

1990s

Gr. = 10%

1980s

Gr. = 10%

2000 +

Gr. = 9%

1990s

Gr. = 9%

1980s

Gr. = 9%

1970s

Gr. = 9%

BGS 227 264 46 333 – – 44 86 176 –

GAI 23 198 92 185 – – 55 124 128 –

SGC 29 125 4 303 – 201 (27) (65) (1) –

PSA 368 238 (2) 25 47 178 (50) (53) (5) 683

BCCG 104 112 (14) (15) (11) (3) (68) (72) (25) 20

GEM 116 80.6 (23) 154 (38) (24) – – – –

We selected a stratiﬁed-by-decade of issue sample of 1000 from a population of 12,290 graded rookie baseball cards traded on eBay during August 19–

September 3, 2004.

Gross return to getting a baseball card graded = ((selling price of a graded card – average price of the same card as per Beckett’s baseball card pricing guide

for un-graded cards)/average price of the same card as per Beckett’s baseball card pricing guide for un-graded cards).

Net return to getting a baseball card graded = ((selling price of a graded card – average price of the same card as per Beckett’s baseball card pricing guide for

un-graded cards – the lowest cost of grading option provided by the certiﬁcation service)/average price of the same card as per Beckett’s baseball card

pricing guide for un-graded cards).

The date indicates the decade when the card was issued. A card in the 2000 + category is a recently issued card. The grade 10 is the highest grade issued by

the certiﬁcation service (9.5 is the highest grade issued by BGS and GAI), the grade 9 is the second highest grade issued by the certiﬁcation service.

Dr. James Beckett issued the ﬁrst Baseball card pricing guide in 1979 by

collecting information from baseball card dealers. In 1984 Beckett Publi-

cations was formed primarily as a seller of pricing guides. Over time other

services were added including a magazine and sports card grading services.

Then the company diversiﬁed into developing other pricing guides (e.g.,

football, and comic books) as well. Beckett now sells an annual pricing

guide, a monthly pricing guide, and also provides an online pricing guide.

All certiﬁers have a posted price for grading a single card, but some also

post a higher price for a faster turnaround, or offer a volume discount by

posting a ﬁxed price for a bundle of cards. We used the lowest cost posted

for grading a single card as the cost of certiﬁcation.

K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

289

þ b

Year

þ b

Grade

þ b

GPSA

þ b

GBGS

þ b

GBeckett

þ b

GGAI

þ b

GGEM

þ b

GSGC

þ e

where R

= net Return from getting a rookie baseball card

graded. This is calculated as selling price of graded card

on EBay – (book value of same card in Beckett pricing

guide + minimum cost of certiﬁcation service) divided by

book value of same card in Beckett pricing guide, Year = Ac-

tual year when a baseball card was issued, Grade = score

assigned by an independent certiﬁcation service on a scale

from 1 to 10, increasing in increments of 0.5, GPSA = Grader

is PSA; GBGS for BGS, GBeckett for BECKETT (other than

BGS); GGAI for GAI, GGEM for GEM; GSGC for SGC. These

are the top 6 graders. For each individual top grader, the

test is whether return to the speciﬁc grader is greater than

return from all other 17 graders.

Estimates in Table 5 indicate that the year, grade and

identity of grader have a signiﬁcant relationship with the

return earned by the seller of a rookie baseball card. More

recently issued, presumably lower valued, cards earn a

lower net return (coefﬁcient is negative, p < 0.001) because

the cost of service is the same. This is consistent with the

intuition that older cards tend to be rarer and priced

higher.

As expected, the grade has a positive signiﬁcant

coefﬁcient (p < 0.001); a higher grade from a third party

certiﬁcation service is associated with a higher price.

Certiﬁcation by a strict grader has a signiﬁcantly positive

coefﬁcient on net return (BGS: p < 0.001). Certiﬁcation by

a moderate grader has a smaller (not statistically signiﬁ-

cant) return for two graders (PSA, SGC) and a positive sig-

niﬁcant return for one grader (GAI: p < 0.001). Certiﬁcation

by a lenient grader has a negative coefﬁcient on return

(GEM: p < 0.001). The coefﬁcient is also negative (but not

statistically signiﬁcant) for Beckett’s value brand (BCCG).

Recall from Table 3A that the easy graders (especially

GEM) give all cards rated a 10. It appears that a 10 from

an easy grader does not earn positive ﬁnancial returns;

instead it tends to signals low quality and generates net

losses to the owner.

To examine if BGS contributes more

to return than GAI, we compared the coefﬁcients of these

two variables using the F-test. We do not reject the null

hypothesis that the two coefﬁcients are equal (p < 0.36).

We also tested the equality of the coefﬁcient on BGS, PSA

and SGC respectively. The F-test shows that BGS contributes

signiﬁcantly more return than either PSA (p < 0.001) or SGC

(p < 0.02). The market is not fooled and there does not ap-

pear to be a tendency of a race to the bottom among the card

grading services.

In addition to increased prices, another potential beneﬁt

from certiﬁcation is the improvement of market liquidity

(Bloomﬁeld & Wilks, 2000; Diamond & Verrecchia, 1991).

Liquidity is important to market traders because it in-

creases the probability of a transaction occurring, and lim-

its the possible loss for the seller by narrowing transaction

costs in the market. We thus reran the regression equation

with # of bids as the dependent variable (instead of re-

turn). For bids we ﬁnd a negative coefﬁcient for year (older

cards attract more bids; t = 2.46, p < 0.01). We ﬁnd a po-

sitive coefﬁcient for grade (t = 3.04, p < 0.01), and a positive

coefﬁcient (get more bids) for the two graders who also got

higher returns (BGS, t = 5.45, p < 0.01 and GAI, t = 5.17, p

< 0.01). Certiﬁcation by the two moderate graders PSA

and SGC results in more bids for PSA which has the highest

market share in this baseball card certiﬁcation market

(t = 3.72, p < 0.01) but not for SGC (t = .79, p < 0.42). For

the two lenient graders, there is an increase in bids for

GEM (t = 2.39, p < 0.02), but not for BCCG (t = 1.6,

p < 0.11). Overall, a certiﬁcation by BGS attracts more bids

than a certiﬁcation by any other certiﬁer (smallest

p < 0.03). There is also a grade  certiﬁer interaction for

BGS (t = 2.65, p < 0.01) and PSA (t = 2.02, p < 0.05). Getting

a low grade from BGS can be costly, though getting a high

grade from BGS brings signiﬁcant beneﬁt to the seller. The

number of bids does not vary signiﬁcantly based on grades

issued by any other certiﬁer. Overall, certiﬁcation in this

market increases the liquidity (# of bids) for a wider range

of certiﬁers than was the case for increased returns.

Implications for auditing

In the market for grading baseball cards, seventeen of

the 23 graders offer only certiﬁcation services (i.e., are

independent), whereas six offer additional services related

either to baseball cards (e.g., pricing guides, dealers, mag-

azines) and/or other cards, coins, stamps and other collect-

ibles. The market is dominated by two ﬁrms which cross-

sell other services (PSA and Beckett). Market prices reﬂect

large premiums for cards certiﬁed by Beckett and a smaller

Table 5

Regression analysis.

Coefﬁcient Std. error T statistic

Intercept 109.63 13.23 8.29

***

Year 0.058 0.006  8.5

***

Grade 0.63 0.06 10.64

***

GPSA 0.082 0.174 0.47

GBGS 0.985 0.189 5.20

***

GBECKETT 0.25 0.20 1.25

GGAI 1.26 0.329 3.85

***

GGEM 0.77 0.19 4.00

***

GSGC 0.335 0.30 1.11

We conducted a regression where R

¼ a

þ b

Year

þ b

Grade

þb

GPSA

GBGS

þ b

GBeckett

þ b

GGAI

þ b

GGEM

þ b

GSGC

þ e

= Return from getting a baseball card graded. This is calculated as

selling price of graded card on EBay – (book value of same card in Beckett

pricing guide + minimum cost of certiﬁcation service) divided by book

value of same card in Beckett pricing guide.

Year = Actual year when a baseball card was issued.

Grade = score assigned by an independent certiﬁcation service on a scale

from 1 to 10, increasing in increments of 0.5.

GPSA = Grader is PSA; GBGS = Grader is BGS, GBeckett = Grader is BECKETT

(other than BGS); GGAI = Grader is GAI, GGEM = Grader is GEM;

GSGC = Grader is SGC. These are the top 5 graders. For each individual top

grader, the test is whether return to the speciﬁc grader is greater than

return from all other non-top graders.

Regression (991 df): R

= 0.1498, p < 0.001 (adjusted R

= 0.1430).

***

p < 0.001.

When we add a Grade  Grader interaction term in the regression,

there is a signiﬁcant interaction only for grader BGS (t = 2.45, p < 0.01) and

grader GAI (t = 1.67, p < 0.05). A certiﬁcation by these two graders

generates signiﬁcant positive returns, and market prices are sensitive to

the grades issued by these two graders. The grade issued does not inﬂuence

returns for any other grader.

290 K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

premium for PSA. The remaining ﬁrms, including all 17

independent ones, have small market shares. There is a

broader pattern of beneﬁt from more liquidity (more bids)

for cards that are certiﬁed. Even among the smaller players,

the dominant certiﬁcation agencies are SGC and GAI, both

of whom cross-sell other services. Only one independent

rating agency (GEM) has any signiﬁcant market share.

Ironically, GEM gets its market share by providing rampant

grade inﬂation where virtually all rookie cards graded by

GEM get a grade of 10 (see Table 3A ) and yield a negative

market return (see Table 5). It is clear that being indepen-

dent (in the sense of not cross selling services) does not

lead to success in having a larger market share, or being

valued in this unregulated certiﬁcation market.

In the baseball card certiﬁcation market, the most obvi-

ous potential for grade inﬂation occurs in an agency called

MINT where sellers of cards are asked to specify their own

grades (see Table 2). The empirical distribution of grades

indicates that another certiﬁcation agency (GEM) also in-

ﬂates its grades (see Table 3A). Both MINT and GEM are

independent baseball card certiﬁcation agencies. None of

the cross-selling certiﬁcation agencies engage in grade

inﬂation.

Prima facie, it is difﬁcult to question the value of auditor

independence for the efﬁcient functioning of the capital

markets, especially in the post-Enron–Arthur Andersen

world. Yet, Antle, Grifﬁn, Teece, and Williamson (1997, p.

28) have argued:

Taking a holistic view, we have found that auditors have

many incentives to protect their independence. Legal lia-

bility is signiﬁcant, and any ﬁrm that would damage its

independence risks an avalanche of litigation. Auditors’

have substantial investments in reputations, audit technol-

ogy and methodology, and directly in their ﬁnancial stakes

in accounting ﬁrms. We have found no evidence that the

supply of non-audit services threatens auditor indepen-

dence, and there is a strong intuitive case that accounting

ﬁrms create value by capturing economies of scope be-

tween audit and non-audit services.

Empirical investigations of the audit market have not

been supportive of the hypothesis that provision of advi-

sory services to audit clients impairs the independence of

auditors (Francis, Reichelt, & Wang, 2005, 2006), or have

a bearing on audit fees (Abdel-Khalik, 1990). An experi-

mental study by Dopuch and King (1991) concluded:

‘‘...policy makers who favor proposals to prohibit audit

ﬁrms from providing both MAS and veriﬁcation services

to the same client should contemplate whether the prohi-

bition will have an adverse effect on the market structure

of the audit industry’’ (p. 89).

Our own ﬁndings about the wide-spread prevalence of

conﬂicts of interest in the unregulated baseball certiﬁca-

tion market raise doubts about the validity of the com-

mon sense assumption about the value of independence

of the certiﬁer that under girds the current regulatory re-

gime. Regulation appears to have failed to prevent poor

enforcement of GAAP by audit ﬁrms, especially in the

1990s. Support for blaming the cross-selling of services

for the collapse of proper auditor enforcement of GAAP

appears weak (Kinney, Palmrose, & Scholz, 2004; Simunic,

1984).

In the aftermath of the Sarbanes–Oxley Act (2002), we

have witnessed another meltdown in the ﬁnancial services

industry where auditors again were alleged to be ineffec-

tive in restraining self serving managers (e.g., the Lehman

Brothers’ aggressive use of Repo 105 transactions to move

debt off balance sheet). Perhaps a wider set of issues such

as the rule-oriented nature of GAAP, securities enforce-

ment, transaction structuring and power of management,

rather than just cross-selling of services by auditors, has

a more fundamental impact on impairment of ﬁnancial

reporting quality. In accounting debates there is often a fo-

cus on one variable (e.g., whether IFRS will improve ﬁnan-

cial reporting) rather than a broader understanding of how

accounting standards, auditors, incentives of preparers and

regulators jointly determine ﬁnancial reporting (Ball, Ro-

bin, & Wu, 2003; Jamal & Tan, 2010; Sunder, 2011).

Independence of auditors might be what Einhorn and

Hogarth (1986) call an INUS condition for judging probable

cause (insufﬁcient but necessary part of a complex sce-

nario which is itself unnecessary but sufﬁcient for an effect

to occur). Einhorn and Hogarth (1986) provide the follow-

ing example to illustrate an INUS condition: When a ﬁre

marshal says that X (a short circuit) caused Y (a house ﬁre),

he rarely means that X is either necessary or sufﬁcient for

Y. Rather, it means that X, when conjoined with a particu-

lar set of conditions (ﬂammable material near the short cir-

cuit, no sprinkler system), leads to Y. It is possible that

independence impairment requires some additional set of

conditions to create one (of possibly many) path leading

to ﬁnancial reporting failure. This is consistent with Antle

and Demski’s (1991) analysis of the role of contracting fric-

tions in the presence of information externalities between

multiple services, which led them to call for: ‘‘...an expan-

sive theory of auditing, one that addresses audit proce-

dures, organization of the audit, product bundling,

contracting, and competition’’ (p. 20).

Conclusion

We conduct a ﬁeld study of certiﬁcation of baseball

cards sold on eBay where some certiﬁers are pure auditors

while others cross-sell related services. We ﬁnd that the

market is dominated by cross-sellers, and pure certiﬁers

(who are independent in the sense of not selling other ser-

vices to their clients) struggle to ﬁnd customers in this

market, resorting to grade inﬂation and providing low

quality service. Sticking to strict standards of grading pays;

being independent by not providing other services does

not pay. Surprisingly, strict grading and restricting scope

of service do not go together. The baseball card market

ﬁndings are consistent with the widespread demand for

expert opinion in the economy, even in the presence of po-

tential for conﬂict of interest. There is no race to the bot-

tom; providers of low quality grading appear to do

poorly in the marketplace.

In much of the audit literature and policy deliberations,

independence has been taken as sine qua non of a high qual-

ity audit. There may well be special conditions associated

with the audit of ﬁnancial reporting that make indepen-

dence essential for an auditor to deliver quality service. If

so, it seems reasonable that such special conditions, and

K. Jamal, S. Sunder / Accounting, Organizations and Society 36 (2011) 284–292

291

their logical and empirical links to independence, be identi-

ﬁed and established.

The present study is only a start at attempts to disen-

tangle the consequences of regulation in audit markets

through the use of cross-market studies. Studies that ac-

count for differences and similarities across markets in

analyzing certiﬁcation services and their regulation may

help us better understand the existing audit regime, and

ﬁnd ways of making it more effective.

Acknowledgements

We thank three reviewers, the editor, David Cooper, Jon

Davis, Michael Gibbins, Joel Pike, Brad Pomeroy, Steve Sal-

terio, Tom Scott and Workshop participants at the Univer-

sity of Alberta, Carnegie Mellon University, Chinese

University of Hong Kong, City University of Hong Kong,

University of Kansas, Mannheim University, Nanyang

Technological University, National Taiwan University,

Queens University, Sabanci University, University of Wind-

sor, Yale School of Management, and Participants at the

University of Illinois Audit Symposium and Interdisciplin-

ary Accounting Conference in Copenhagen for helpful com-

ments. We also thank Adam Karbani and Wayne Morgan

for research assistance on this project. Financial support

from the Social Sciences and Humanities Research Council

(SSHRC) of Canada is gratefully acknowledged.

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