Demand for Audit Quality in Private Firms: Evidence on Ownership Effects

Abstract

This study investigates whether managerial ownership related agency costs are associated with the demand for audit quality in a sample of small private firms. The literature on audit quality suggests that firms with high agency costs are more likely to demand audit quality. Our database enables us to compare the demand for audit quality with three different measures: demand for Big 4 auditors and two types of certified auditors with strict professional requirements. The results show that an increase in managerial ownership decreases the likelihood that the firm will engage a Big 4 auditor or a KHT certified auditor but it does not have an impact on the demand for lower level certified auditors. Our findings also support previous studies that suggest a nonlinear connection between managerial ownership and the demand for audit quality in terms of Big 4 audits. This suggests that higher quality audits by Big 4 audit firms are used to overcome agency costs induced by information asymmetries between shareholders and managers. An increase in leverage, on the other hand, increases the likelihood that the firm will engage a lower level certified auditor as opposed to a non-certified auditor.