Demand for and Assessment of Audit Quality in Private Companies

Abstract

Financial statement audits are mandated in most countries, thus making it difficult to distinguish between auditing driven by private incentives versus that driven by regulation. Who would ask for an audit, and how would its quality be assessed in the absence of regulation? Many private companies in Canada get their financial statements audited even though the law does not require it. In this field study, we conduct interviews to discover reasons for demanding an audit, and criteria used to assess their quality. Our study reveals that both internal stakeholders (management, boards, and employees) as well as external stakeholders (customers, banks, and private equity firms) request audits. Users evaluate audit quality based on a variety of criteria such as the auditor's accounting expertise, the absence of errors, the fees involved, risk assessments offered, allocation of effort, internal control, and general business advice. Implications for audit regulations are discussed.

Do Relatively More Efficient Firms Demand Additional Audit Effort (Hours)?

“…The managers of high‐performing firms are likely to accept the audit effort request of shareholders to reduce objections to performance‐related benefits. Third, as suggested by Esplin et al (2018) creditors, suppliers and other equity stakeholders require assurances that financial reporting quality is accurate to set credit terms. Therefore, we conjecture that management will accommodate the audit quality demands of external stakeholders.…”

“…Thus, as Esplin et al. (2018) suggest, audit effort can be demanded by both internal stakeholders and external stakeholders.…”

Audit partner rotation, and its impact on audit quality: Evidence from India

“…Auditing is valued for its role in providing independent assessment and credibility of accounting information (M. DeFond & Zhang, 2014;Esplin et al, 2018). It is expected to reduce information asymmetry that exists between managers and other firm stakeholders by allowing outsiders to verify the validity of financial statements.…”

Audit fees and cost of debt: differences in the credibility of voluntary and mandatory audits

“…On the other hand, theory suggests that demand for audit increases as agency problems rise (DeFond & Zhang, 2014;Esplin et al, 2018). In that sense, higher audit fees may be perceived as the result of a more effective monitoring by the auditor, and a consequence of the audit effort (more work hours) and the auditor experience (higher fees per hour), what involves a mitigation of agency costs, and a decrease in the financing costs.…”

“…We have to note that audits are credence goods (Causholli & Knechel, 2012;Esplin et al, 2018;Hay & Knechel, 2010;Knechel et al, 2008), the main feature of them is that the consumer cannot ascertain either the quality of the good or the need for it, and thus price is often the only possible indicator of quality on credence goods (Dulleck & Kerschbamer, 2006;Hay & Knechel, 2010). As we stated in Section 2.1, lenders may not rely on voluntary audits because some companies may pretend to feign a commitment with accounting quality when they do not really have it.…”