Size Management by European Private Firms to Minimize Disclosure and Audit Costs

Abstract

Mandated public disclosure of financial statement information potentially subjects the firm to proprietary costs. In Europe, disclosure requirements increase at bright-line firm size thresholds, creating incentives to manage size to remain below the thresholds. We examine evidence of size management among small private firms, a setting where proprietary costs of disclosure should be relatively important. Audit requirements for these firms are also linked to size thresholds. In situations where the disclosure and audit thresholds coincide, we find substantial evidence that firms manage size to remain below the threshold, which suggests that combined costs of mandated disclosure and net audit costs exceed the costs associated with size management. In settings where the disclosure and audit thresholds are separate, we find 1) no significant evidence of size management to remain below the disclosure threshold, but 2) significant evidence of size management to remain below the audit threshold. This evidence suggests the costs of mandated disclosure are typically smaller than the costs of size management while net audit costs are typically larger than the costs of size management. Because net audit costs are relatively low for small private firms, the empirical evidence provides little support for the proposition that mandatory disclosure of financial statement information imposes substantial proprietary costs.