Unobservable service quality and moral hazard: the case of impartial business valuations

Abstract

PurposeThe purpose of this paper is to discuss agency relationships occurring in an impartial business valuation setting. In particular, it shows how monitoring and sanctioning mechanisms, reputational concerns, and competition may affect the quality of valuation services rendered.Design/methodology/approachThe paper reviews findings from auditing research and from the economic theory on credence goods, and applies them to an impartial business valuation setting.FindingsImpartial valuation experts face incentives to either overwork, or underwork and overcharge their client. Which type of moral hazard is more likely to occur depends on the degree of competition among the agents. While market concentration gives rise to overworking, competition promotes underworking and overcharging. Due to regulatory differences, this effect is more pronounced in the valuation services market than in the auditing industry.Research limitations/implicationsThe results imply that a client may be able to infer how to set up an effective monitoring and sanctioning system from the degree of competition among the impartial valuation experts. Future research should empirically validate the theoretical findings, and explore the relationship between service quality and internal governance structures of business valuation firms.Practical implicationsThe results underline the necessity of an effective valuation quality assurance system set up by the client. They are thus relevant for clients, but also for regulatory bodies seeking to ensure the integrity of the valuation services market, and for valuation service providers striving to improve their corporate governance system.Originality/valueThe paper offers a new perspective on the reliability of business values determined by impartial experts. It emphasises the potential influence of the experts' competitive environment on service quality, and it shows how to design an effective valuation quality assurance system.