Regulation and Markets in a
Certification Society: Financial
Reports vs. Baseball Cards
Karim Jamal and Shyam Sunder
Illinois Audit Symposium
September 2006
Summary
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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
Regulatory Attempts to
Improve Auditing
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Seven decades of regulation under the SEC –
regulation cannot prevent audit failure
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Major changes in regulation in 2002 (SOX) to
promote auditor independence (and Quality ?)
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Controversy over whether these reforms improve
auditing (Kinney et al., 2004)
Extent of Certification Services
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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?
The Audit Society
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“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
Sample Selection
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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
Types of Certification Services
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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%
Extent of Certification
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Results suggest support for Power’s
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
Data Obtained from One
Official Partner of eBay (XYZ)
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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
Self-Assessment of XYZ’s
Experts
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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
Implications for Auditing
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Conflict of interest appears to be
pervasive (norm) in certification services
in general (79%), not confined to auditing
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Unacceptability of consulting services to
audit clients in a regulated market (Francis
2004) contrasts sharply with this data from
unregulated domains
Fineness of
Ratings/Certification
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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
Shouldn’t a finer report be more informative to
users of the audit report?
Economic Theory
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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
Data on the Fineness of
Government Standards
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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)
Greater Variability in Fineness
of Scales in Private Standards
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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)
Market for Baseball Card
Certification Services
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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)
Comparison with the Market
for Audit Services
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Only binary pass/fail reports, little further detail
permitted
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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?
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The current system suppresses the detailed
knowledge gained by the auditor; more
consistent with govt. not private markets
Value of Certification in Sports
Card Market
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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)
Data for Assessing the Value of
Certification Services
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321,045 cards traded on eBay during August 19September 3, 2004
Partitioned cards by decades of origin, singlerookie, 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
Assessing Strictness of
Grading
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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 (selfselection bias): BVG’s premium service stands out (GAI,
SGC)
Becket’s 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?
Pricing and Value of Baseball
Card Certification Services
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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
Returns to Audit
Rater
Gross Return
Net Return
BGS
264%
46%
GAI
198%
92%
SGC
125%
4%
PSA
238%
(2%)
BCCG
112%
(14%)
GEM
80.6%
(23%)
Table 7: Regression Analysis
Ri = 1+ 1Yeari + 2Gradei + 3GPSAi + 4GBGSi + 5GBecketti
+6GGAIi + 7GGEMi + 8GSGCi + ei
Regression (990)df, R2 = 0.1747, p < 0.001. (Adjusted R2 = 0.168)
Intercept
Year
Coefficient
Std Error
108.68
12.60
T Statistic
8.63 ***
-0.058
0.006
-8.97 ***
Grade
0.72
0.06
12.65 ***
GPSA
0.37
0.16
2.22**
GBGS
1.12
0.18
6.25***
GECKETT
-0.18
0.19
-0.98
1.21
0.31
3.87 ***
GGEM
-0.73
0.18
-3.97***
GSGC
0.48
0.28
1.68*
GGAI
*** p <0.001
** p < 0.01
* p < 0.05
Regression Analysis
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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
Back to Auditing
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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?
Skepticism about Deregulation
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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?
Concluding Remarks
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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
Open Questions
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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?