Why Do Private Companies Demand Auditing? A Case for Organizational Loss of Control

Abstract

The objective of this paper is to explain the motivation for owners of private companies to voluntarily demand audit (positive) assurance. It is hypothesized that the owner/manager seeks audits as compensatory control systems for the organizational loss of control inherent in hierarchical organizations. Thus, the expected value of wealth at risk due to loss of control sets a lower limit on the amount owners would be willing to pay for audits to compensate for that loss. The hypothesized relationship was tested using information for 103 private companies demanding audit (positive) assurance. The obtained relationships were basically unaltered by the introduction of lenders' requirement of audits (n = 40). Furthermore, the hypothesized compensatory aspect of audit assurance was absent for the demand for negative assurance (reviews) in a sample of 31 companies. This is consistent with the fact that negative assurance is not viewed as a way of providing confidence so as to compensate owners for loss of direct supervision and control.

Small is big! The role of ‘small’ audits for studying the audit market

“…Furthermore, the level of shareholder-debtholder agency costs and contractual constraints imposed by creditors on the rm seem to be a key driver for the demand of Managers of SMEs may use an external audit as an internal control mechanism when organizational complexity increases -e.g. to compensate for the hierarchical loss of control over employees when a company increases in size (Abdel-Khalik, 1993;Senkow et al, 2001;Seow, 2001). SMEs may also demand voluntary audits expecting to get from auditors skills and resources not available within them.…”

Näkökulmia tilintarkastukseen ja arviointiin

“…Tilinpäätösraportointi eroaa merkit-tävällä tavalla arvopaperipörssiin listautuneiden yhtiöiden ja ei-listautuneiden yhtiöiden välillä (Ball & Shivakumar 2005). Ei-listautuneiden yhtiöiden sisäi-seen valvontaan liittyvät kontrollijärjestelmät ovat vähemmän muodollisia ja tilintarkastus saattaa korvata heikommin kehittyneitä sisäisiä kontrolleja (Simunic & Stein 1987;Abdel-Khalik 1993;Carey ym. 2000).…”

The Relationship between an Independent Audit and Financial Reporting Quality: Evidence from Small Private Commercial Banks

“…As a company grows in size it becomes more difficult for owners and managers to be observant of all facets of operations. Hence, (Tauringana and Clarke 2000;Chow 1982;Abdel-Khalik 1993) find that as the company size increases the likelihood of procuring an audit increases. The log of total assets is used to proxy for size (LTA).…”