Acknowledgements: We thank the Editor, two anonymous reviewers, Jill Collis, Mara. Cameran, Robin ... monitoring the external accountant through a voluntary audit. .... certification have been allowed to audit the smallest firms in Finland. 3.
DRIVERS OF VOLUNTARY AUDIT IN FINLAND: TO BE OR NOT TO BE AUDITED? by Lasse Niemia, Juha Kinnunena, Hannu Ojalaa, and Pontus Trobergb
a
Aalto University School of Economics, Finland b
Hanken School of Economics, Finland
Forthcoming in Accounting and Business Research Vol. 42 (2012)
-------------------------------------------------------------------------------------------------------Acknowledgements: We thank the Editor, two anonymous reviewers, Jill Collis, Mara Cameran, Robin Jarvis, Don Stokes, the participants of the Aalto University School of Economic’s accounting research workshop, the 5th Annual Workshop on Accounting in Europe, hosted by the University of Catania, Italy (2009), the 5th EARNet Symposium on auditing research, hosted by the University of Valencia, Spain (2009) and European Accounting Association 33rd Annual Congress held in Istanbul (2010), for their constructive and insightful comments on earlier versions of this paper. We are most grateful to Juha Ahvenniemi and Sirpa Airola from The Association of Finnish Accounting Firms for providing access to proprietary case materials. We gratefully acknowledge the financial support of the Paulo Foundation.
-----------------------------------------------------------------------------------------
1
DRIVERS OF VOLUNTARY AUDIT IN FINLAND: TO BE OR NOT TO BE AUDITED?
Abstract
This paper examines factors affecting the owner-manager’s decision to hire an auditor in small firms. Using a random sample of 412 small private companies in Finland responding to an Internet survey, we first probe the institutional boundaries of a prior UK study (Collis et al. 2004) and conclude that its main findings can be generalised to a different regulatory setting (Finland) typical of many Continental European countries. Second, we broaden the prior research by testing new hypotheses regarding the drivers of an audit among small companies. We hypothesise and find evidence that outsourcing critical accounting functions creates information asymmetry between the owner-manager and the external accountant, which may arouse the need for monitoring the external accountant through a voluntary audit. In addition, we find, as hypothesised, that tax advisory services provided by the external accountant reduce the likelihood of a voluntary audit. Moreover, we hypothesise that receiving a qualified opinion from the auditor reduces the likelihood of hiring an auditor voluntarily whereas firms experiencing financial distress would be more willing to have their financial statements audited. We find evidence consistent with these hypotheses.
Key words: agency theory, alignment of financial and tax accounting, information asymmetry, moral hazard, small companies, voluntary audit
2
DRIVERS OF VOLUNTARY AUDIT IN FINLAND: TO BE OR NOT TO BE AUDITED?
1. Introduction To be or not to be audited? This is the question that many small companies face when operating under regulatory settings that exempt firms from mandatory audits. This study seeks to explain why small companies respond differently from one another to this question by examining the drivers of demand for audits among these firms.1 Using data from an Internet survey conducted in Finland at the end of 2005, we first probe the institutional boundaries of a recent study on small companies in the UK (Collis et al. 2004) with the aim of discovering whether its findings on the drivers of voluntary audits also apply in a different regulatory setting. Even though both the UK and Finland are members of the European Union, there are some significant differences in corporate finance, tax, and legal systems that affect accounting and auditing (Nobes 1983, Margerison and Moizer 1996, Baker et al. 2001, Nobes and Parker 2008), and these differences may have an effect on the demand for voluntary audit. Second, we argue that some previously unexplored small firm-specific characteristics may also drive the decision to have financial statements audited. On one hand, consistent with our unique proprietary case evidence, we hypothesise that outsourcing of critical accounting functions creates an agency-type relationship between the owner-manager and his/her external accountant which may increase the need for an independent audit. On the other hand, we hypothesise that the incumbent external accountant, who is the preparer of the financial statements and therefore is
3
extensively familiar with the client’s business, may be a more cost-efficient provider of advisory services in taxation than the auditor of those financial statements, thereby reducing audit demand. 2 In addition to the role(s) of the external accountant in small companies, we argue that two other factors influence voluntary decisions to hire an auditor, namely, a conflict between the owner-manager and the auditor attributable to a qualified audit report (e.g., Beattie et al. 2000, 2004, Mohr and Spekman 1994), and firm financial distress (Beattie et al. 2004). Our study adds to the literature in two main ways. First, we show that, in spite of some major institutional and regulatory differences, the boundaries of the findings reported by Collis et al. (2004) from the UK can be extended to comprise settings typical of Continental European countries such as Finland. For instance, while Collis et al. (2004) report that 63% of small UK companies would choose to have their accounts audited if they were exempt, the corresponding percentage in our Finnish sample is 60%. Furthermore, we document that many of the drivers of audit demand examined by Collis et al. (2004) are significant also in our sample. Second, based on our Internet survey combined with archival data on audit reports and financial distress of the responding firms, we find evidence for some additional drivers of audit demand that are specific to small firms. In particular, our study shows that hiring an external accountant has two opposite effects on the demand for nonmandatory audits. While tax advisory services available from an external accountant reduce the willingness to hire an independent auditor, outsourcing of critical accounting functions creates a need to control information asymmetry (moral hazard) between the firm and its external accountant which, in turn, increases the willingness to have an independent audit.
4
In addition, we find some evidence that receiving a qualified audit report may affect negatively on the demand for non-mandatory audits in the future. Finally, our finding that firm financial distress may increase the likelihood of hiring an auditor is consistent with the view that professional advice from an auditor may be useful for a client seeking a way out of a financially difficult situation. In summary, our findings add to knowledge regarding the role of audits in small companies. The remainder of the paper is organized as follows. In section 2, we provide a brief description of the institutional and regulatory setting (Finland) of this paper. We discuss relevant prior literature and develop our hypotheses in section 3. Section 4 describes the data and models used in the empirical tests. The results from these tests are reported in section 5. The paper concludes with a brief summary of the main findings and implications in section 6.
2. Institutional and regulatory setting (Finland) Finland joined the European Union (EU) in 1995. As a member state of the EU, the regulation of auditing in Finland complies with the directives of the European Commission. However, as legislation on auditing and accounting is issued at the national level in the EU countries, differences in legal frameworks relating to corporate finance and taxation influencing the auditing environment remain (European Commission 1996, 1998, 2000, 2003, Nobes 1983, Baker et al. 2001, Margerison and Moizer 1996, Nobes and Parker 2008). In general, countries are classified by their legal systems as code law countries and common law countries (LaPorta et al. 1998, Nobes 1983). In code law countries, even large companies are often privately held (Jaggi and Low 2000), auditors face a low litigation risk (Niemi 2002), and the audited financial statements of companies
5
provide the basis for their tax reporting (e.g. Ali and Hwang 2000). These three characteristics of a typical code law country also apply to Finland (Niemi and Sundgren 2008). For small companies, however, differences in ownership structure and litigation risk between code law and common law countries are likely to be of less relevance than for their large publicly held counterparts. Clearly, there is little variation in ownership structures among small companies in any legal system. Also, the litigation risk concerning auditing of small privately held client firms is likely to be low regardless of the legal system of the country. Another difference among EU countries is the system for auditor certification. A two-tier system of certification has been adopted in the Nordic countries including Finland and in many ‘Continental European Model’ countries such as Germany and France. In Finland, however, small companies have until recently been allowed to hire an auditor who does not fulfill the professional requirements of the Eighth Directive. Consequently, in addition to two tiers of certified auditors, persons without certification have been allowed to audit the smallest firms in Finland. 3 An additional difference related to the market for audit services in the EU is that the requirements regarding statutory audits for small companies vary from country to country. Some EU countries have set the company size threshold for audit exemption at the maximum permitted by the EU directives whereas others have set the exemption thresholds at a much lower level. At the time of the survey (late 2005) on which our data are based, foregoing audit was not an option in Finland. Concepts of financial statement audits are quite similar across the EU. Despite the existence of different tiers of auditors, all audits in Finland are ‘full’ statutory financial statement audits as stipulated by the Auditing Act (936/1994 and 459/2007). Moreover, good auditing practice is to a great extent based on International Standards
6
on Auditing (ISAs) and the Code of Ethics provided by International Federation of Accountants (IFAC) (Niemi 2004, Niemi and Sundgren 2008). The Act does not permit alternative assurance services, such as compilations, reviews or agreed-upon procedures engagements, allowed in some other countries such as in the US. Finally, our setting is suitable for testing the hypothesis that prior conflicts between the auditor and the client arising from qualified audit reports may reduce the latter’s willingness to have an audit in the future. Namely, all respondents in our survey had undergone a financial statement audit, and they also knew at the time of the survey that in the near future audits may not be mandatory for small companies in the country. In contrast, in a different setting where audits are non-mandatory, only those companies that have been audited can have an experience of conflicts with their auditor.
7
3. Previous research and development of hypotheses 3.1. Macro-level drivers of demand for audits The demand for auditing arises from information asymmetries and conflicts of interest between principals and agents (Jensen and Meckling 1976, Watts and Zimmerman 1986, pp. 185-186, 319). However, the nature and extent of these information asymmetries and conflicts of interest are likely to vary between different institutional settings and across firms within a given institutional setting. A major source of differences between institutional settings is regulation. Watts and Zimmerman (1986, p. 336) note: “Regulation affects the nature of the audit. It expands the audit. The auditor is responsible, and legally liable, for information beyond that used in contracts.” Also Benston (1985) and Wallace (2004) acknowledge and explore the complex link between regulation and the nature of an audit. In their study covering twenty countries, Taylor and Simon (1999) find that litigation pressures, institutional traditions of disclosure, and regulation of accounting and auditing are macro-level factors that explain international differences in the levels of audit fees. In addition, the effect of the degree of alignment between company taxation and financial reporting on accounting and auditing regulation differs significantly between Anglo-Saxon and Continental European countries (Nobes 1983, Alford et al. 1993, Ali and Hwang 2000, Nobes and Parker 2008). Taxation is likely to play a more significant role in accounting choices for small companies than for large listed companies (see, e.g. Cloyd et al. 1996). Hence, the impact of the degree of the alignment between financial and tax reporting is likely to be even stronger among small companies than among listed companies.
8
3.2. Micro-level drivers of the demand for audit 3.2.1. Publicly held companies Even if the effect of regulation on the players in the market were the same, the demand for auditing would probably still vary across the players due to variations in firm-specific agency costs. In his pioneering study in the area, Chow (1982) examined the drivers of the choice between being audited and not being audited among listed companies in the US in the early 1900s when auditing was non-mandatory for these firms. He found that the choice of being audited is driven by firm size, capital structure, and the number of debt covenants written in terms of accounting numbers. He argued that firm size proxies two effects: (1) managerial ownership decreases as firm size increases, and (2) there may be fixed (start-up) costs of providing audits, and therefore audit costs decline with firm size. The majority of prior studies in the area of the demand for audit focuses on publicly held corporations. In essence, these studies link the demand for auditing, or audit quality, to agency costs arising from agency relationships between providers of equity capital and debt capital, and those between the management and providers of capital (equity and debt) (e.g. Chow 1982, Francis and Wilson 1988, DeFond 1992, Anderson et al. 1993, Willenborg 1999, Pittman and Fortin 2004).
3.2.2. Privately held companies Until recently, there has been much less research on the demand for auditing focusing on small and medium-sized firms compared to their large listed counterparts. As a whole, an analysis of above mentioned studies suggests that the nature and extent of information asymmetries and conflicts of interest between principals and agents in small companies differ from those of listed companies. There are at least three
9
noteworthy differences between small companies and large publicly held corporations, namely those relating (1) to the separation of ownership and control, (2) to internal control quality, and (3) to the need to outsource critical accounting functions due to a lack of required know-how and other resources necessary to manage these functions internally. First, the degree of separation between ownership and control (Fama 1980) is lower in small companies. In small companies, the agency relationship between providers of debt and management is likely to be a more important driver of the demand for auditing than the relationship between owners and management typical of large listed companies with more dispersed ownership structures (Chung and Narasimhan 2001, Collis 2008, Hay and Davis 2004, Knechel et al. 2008). Recent studies examining privately held firms have in fact found evidence that the cost of debt is a driver of voluntary audits (Blackwell et al. 1998, Kim et al. 2007, Minnis 2011, Willekens 2008). Second, internal control systems in small companies are less formal and external auditing may thus serve as a remedy for weaknesses in internal controls (AbdelKhalik 1993, Carey et al. 2000, Simunic and Stein 1987). Abdel-Khalik (1993) argues that even in the absence of separation of ownership and control an owner-manager seeks auditing for two reasons, namely to comply with constraints placed on the company by creditors and to provide a control mechanism to offset the loss of organizational control. The loss of organizational control cannot be remedied by internal control as it is itself part of the organization. The following quotation captures the essence of his argument (Abdel-Khalik 1993, pp. 37-38): “Indeed, a primary function of external audits is to evaluate the quality and adequacy of internal control systems… Importing external monitoring systems is particularly important for smaller
10
companies, whose scale of operations does not facilitate making large investments in internal control systems.” Third, consistent with Abdel-Khalik’s (1993) argument about the outsourcing of internal control tasks to an external auditor, we argue that a similar reason (i.e., a need to outsource critical accounting functions due to the lack of specialised resources) creates a need to contract with two providers of accounting–related services, one that performs the accounting (the external accountant), and the other that audits it (the auditor). We argue that the (dis)incentives for hiring two service providers add to the set of drivers of voluntary audits in small companies. We will further elaborate on this argument in the next section.
3.3. Hypotheses development 3.3.1. The impact of contracting relationship between the firm and its external accountant Small firms generally have very limited resources and expertise available for financial accounting tasks, such as bookkeeping, payroll accounting, accounting for value added taxes, preparation of financial statements, and tax reporting (e.g. Gooderham et al. 2004, p. 7). To solve this resource problem firms typically outsource (‘subcontract’) these functions to an external accountant. We argue that outsourcing of these critical accounting functions creates a contracting relationship between the owner-manager and the external accountant in a similar way to outsourcing production to an industrial subcontractor. More specifically, we suggest that this relationship may induce an information asymmetry problem (moral hazard) between the contracting parties. 4 This problem arises because the owner-manager cannot directly observe and monitor the effort (and quality) level of his/her external
11
accountant (cf. Jensen and Meckling 1976, Holmström 1979, Fama 1980, Scott 2009, pp. 313-317). To illustrate how moral hazard in this contracting setting manifests itself in actual practice, we present some real-life case examples in the Appendix. These cases are abstracted from documents comprising customer complaints confidentially received from The Association of Finnish Accounting Firms for the purpose of this study.5 Overall, the proprietary materials received for the study include twenty-four cases. From these materials, we can identify cases representing ‘shirking’ as well as cases representing ‘stealing’ types of moral hazard (see, e.g., Roe 2005, Scott 2009). A common characteristic of both types is that the external accountant may have redirected, or at least may have had the opportunity to redirect wealth from the ownermanager to either him/herself or to third parties. The cases show that under ‘stealing’ the wealth transfer takes the form of collusion, appropriation, or tunnelling the ownermanager’s wealth to third parties under the auspices of his/her accountant (cases 1 and 2). Correspondingly, under ‘shirking’ the wealth transfer typically transpires in the form of overpricing the accounting services relative to what has been agreed upon in the service contract (see cases 3 and 4 in the Appendix) or relative to the actual quality of accounting services received. Poor quality can be attributed to software problems (cases 5 and 6), reporting delay (cases 7 and 8), or suspected errors in bookkeeping (cases 9 and 10).6 It is noteworthy that in some cases (e.g., 5 and 7) the auditor has played an explicit role as a whistle-blower in disputes concerning quality problems in accounting services received. Given this confidential and unique case evidence, we have grounds to argue that, in order to control for the possibility of moral hazard, the owner-manager may have an incentive to hire an auditor with the expertise and other necessary resources to assure
12
that the external accountant does not behave opportunistically. Thus, from an information asymmetry perspective we can expect that voluntary audits complement the services provided by an external accountant to the company. We therefore hypothesise as follows:
H1: Ceteris paribus, non-mandatory audit is positively associated with the extent to which the firm deems the financial accounting services provided by an external accountant important.7
3.3.2. The impact of external accountant's competitive advantage in providing tax advice Due to the lack of in-house specialists, most small firms need external business advisors (Bennett and Robson 1999, Gooderham et al. 2004, Jarvis and Rigby 2010). Surveys of SMEs in the UK and Australia find that a great majority of small firms uses at least one source of external business advice, and that the market for advisory services is dominated by ‘high trust’ specialist sources such as accountants and lawyers, accountants being by far the most common source of external advice (Bennett and Robson 1999, p. 166; Blackburn et al. 2006, p. 21; Blackburn et al. 2010, p. 5). Of advisory services that small accounting firms provide, tax-related services seem to be the most widely used of all services provided (e.g. Leung et al. 2008, p. 5, Van Peursem and Wells 2000, p. 73). Both the external accountant and the auditor of a small firm can be competent providers of tax-related advisory services to the owner-manager 8. Indeed, the survey of small firms conducted by Poutziouris et al. (1999) in the UK indicates that while a vast majority (68%) of the owner-managers of small firms are always or often involved in tax planning themselves, in most cases (74%) it takes place in collaboration with an auditor and/or an accountant. Likewise, Van Peursem and Wells
13
(2000, p. 73) find in their survey of accounting professionals in New Zealand that a majority (52%) of small accounting firms regards tax planning and tax reporting as their primary advisory services. Moreover, Gooderham et al. (2004) note that small client firms are willing to pay more for advisory services than for ‘standard accountancy services’. This is consistent with the view that accounting firms may achieve competitive advantage through successful product differentiation in the form of developing advisory services to their clients (Simunic and Stein 1987). A recent survey conducted among small firms in Finland shows that ownermanagers prefer external accountants to auditors as providers of tax advisory services (Syrjä 2010). Interestingly, this tendency seems to be independent of the tax planning profile of the small firm in question, be it an ‘outsourcer’, ‘tax minimiser’, ‘tax neutral’, or ‘knowledgeable’ small firm. Under all these tax planning orientations, firms generally seem to consider the help from an external accountant more useful than from their auditor (Syrjä 2010, pp. 134-135). A plausible explanation for the extensive use of the services of the external accountant is his/her competitive advantage over an auditor in providing tax advice. This competitive advantage is likely to arise from cost efficiency, because unlike an auditor who is less involved in details concerning daily bookkeeping and the preparation of financial statements, the accountant is more familiar with all the relevant issues related thereto. Arguably, this is the case not only during but also by the end of a fiscal year when significant tax-driven transactions (such as purchases and sales) are exercised, as well as after the end of the fiscal year when financial statements are prepared. Consistent with this, typically it is the external accountant preparing the financial statements who also prepares the tax return. For example, Cassar and Ittner (2009) find in their study of US start-up businesses that a decision to
14
hire an external accountant increases if the business has filed a federal income tax return. In addition, Cloyd et al. (1996) report that in a vast majority (65.7%) of private firms in the US, accounting choices are either driven by or made in conjunction of tax planning. It is also noteworthy that tax planning is beyond the scope of financial statement audit, which may further increase competitive advantage of the preparer of financial statements over the auditor of those statements. While tax considerations have a significant impact on accounting choices in small firms in any jurisdiction, the impact is likely to be even stronger where there is high alignment between financial and tax reporting. In that regard, e.g. Van Tendeloo and Vanstraelen (2008, pp. 448 and 454) note that there is in general a higher alignment between financial and tax reporting of private firms in countries such as Belgium, Finland, France and Spain than in some other countries such as Netherlands and the UK. 9 In Finland for example, only the transactions recorded in bookkeeping and presented as revenues and expenses in the statutory income statement are allowed to be considered when taxable income is calculated.10 In summary, it is reasonable to assume that in general, and particularly in jurisdictions with a high alignment between financial reporting and firm taxation, the external accountant has a competitive advantage over the auditor in providing tax advisory services to the owner-manager of a small firm. We thus posit the following hypothesis:
H2: Ceteris paribus, non-mandatory audit is negatively associated with the extent to which the firm deems the tax advisory services provided by an external accountant important.11
15
3.3.3. The impact of a qualified audit report In the conduct of an audit, the auditor interacts with the owner-manager and employees of the client firm. Discussions on various issues take place and may lead to negotiations aimed at reconciling the possible conflicting views between the auditor and the client management (Beattie et al. 2000, 2004)12. These negotiations that auditors experience as a normal part of their practice can materially affect the financial statements (Beattie et al. 2000, Gibbins et al. 2001, Johnstone et al. 2002, Patel et al. 2002, Tsui and Gul 1996). For example, in their survey of 300 financial directors of UK listed companies and 307 audit engagement partners Beattie et al. (2000) find that negotiation results in a change in the financial statements in the majority (57%) of the cases. In the negotiations both sides generally strive towards joint problem solving by the use of different conflict resolution techniques rather than trying to dominate or ignore the problem (Mohr and Spekman 1994). Mohr and Spekman (1994, p. 139) note that the impact of conflict resolution on the relationship can be constructive or destructive. When parties engage in joint problem solving, a mutually satisfactory solution may be reached which consequently enhances the success of the relationship. The use of destructive conflict resolution techniques (e.g. domination, confrontation) are seen as counter-productive and are very likely to strain the fabric of the relationship. In the context of auditing, Bame-Aldred and Kida (2007) find that auditors and clients approach conflict resolution in different ways. In essence, managers are more flexible in using different negotiation tactics such as ‘bargaining’ and ‘trading off’ one reporting issue for another whereas auditors consider their accounting decision to be less open for negotiation. Bame-Aldred and Kida (2007) see that the auditors’ narrower solution set and negotiating flexibility on accounting issues are likely to
16
relate to auditing rules and professional guidance. For example, trading off one financial accounting issue for another could be viewed as an unprofessional conduct or even as a violation of existing independence rules, not only by peers but also by outside constituents such as investors, regulators and legislators. They divide the tactics that auditors and clients use for conflict resolution into problem-solving and contentious tactics. As to contentious tactics, the lowest rated tactics are that the auditors threaten to qualify the opinion or the clients threaten to terminate the relationship (Bame-Aldred and Kida, 2007, p. 507). Consistent with the auditor-client negotiation literature, studies on qualified audit reports and auditor switches suggest that qualified reports are, using Mohr and Spekman (1994) classification of conflict resolution techniques, rather destructive than constructive for auditor-client relationship. Several studies find that even though opinion shopping is generally unsuccessful, firms switch auditors more frequently after receiving qualified reports (Carcello and Neal 2003, Chow and Rice 1982, Craswell 1988, Lennox 2000). Carcello and Neal (2003, p. 97) explain that either management believes that it will find a more pliable auditor, or management may dismiss the auditor as a punishment or due to irreparable damage to its relationship with the auditor. Building on the above review of general conflict resolution literature, studies on auditor-client negotiations, and studies on qualified audit reports and auditor switches, an owner-manager’s prior experiences of mandatory auditing can be expected to affect the demand for voluntary audits. If prior experiences are ‘contaminated’ by conflicts caused by a qualified audit report, the owner-manager’s willingness to engage in non-mandatory audit is presumably lower than it would be otherwise. If the company simultaneously to a large extent relies on outside (debt) financing, the
17
conflict can be accentuated because the financing and thereby the continuity of the enterprise may become jeopardised. Indeed, as Craswell (1988, p. 23) notes, there are costs associated with receiving qualified opinions which managers may avoid by switching auditors. However, as prior studies show, opinion shopping is usually not successful in that the subsequent auditor is also likely to give a qualified report (Lennox, 2000). Therefore, the safest option to avoid a qualified audit report is not to have an audit, if it is voluntary. Especially in the case where a qualified audit report and the underlying reason for it have been the source of disagreement between the owner-manager and the auditor, a plausible avenue for conflict resolution is to abandon the audit when it becomes nonmandatory. Thus, we expect that prior experiences from conflicts attributable to qualified audit report(s) under mandatory audit have a negative effect on demand for non-mandatory audits:
H3: Ceteris paribus, non-mandatory audit is negatively associated with receiving a qualified audit report in the past.
3.3.4. The impact of firm financial distress. We expect that a firm’s financial distress manifested in the form of a bankruptcy threat (see e.g. Altman 1968, Laitinen and Laitinen 2004) can be another driver of demand for voluntary audits. First, it is reasonable to assume that an owner-manager of a small firm, especially when (s)he has little or no training or prior experience in solving financial problems, may find professional advice from an experienced auditor useful in seeking a way out of financial distress. The importance of auditor advice of this sort can even increase under dispersed ownership due to increased information asymmetry and related agency costs (Jensen and Meckling 1976).
18
Second, under financial distress it is more likely that voluntary audits are in the interests of outside providers of debt capital (banks and other financial institutions) not only because of the expertise needed to solve the financial problems, but also because of the need to decrease the possibility of moral hazard, that is, ownermanagers (insiders) behaving opportunistically under financial distress (cf. Simunic and Stein 1987, p. 9). Indeed, financial distress is found to be a key driver of aggressive accounting (e.g. Beattie et al. 2004). In their survey of audit engagement partners of listed firms in the UK, Beattie et al. (2004, p. 16) find that financial reporting quality could rapidly change when the conditions of the company change, particularly when there is a need to stay within the constraints of debt covenants. Hence, the lender-borrower agency conflict between a small firm and its debt holders will presumably gain further impetus under financial distress. While the default risk encountered by a lender of a distressed small firm is reflected in the required risk premium, it is in the best interests of the firm and its owner(s) to keep the finance expenses of the firm as low as possible. Assurance provided by a voluntary high-quality audit can provide effective means to achieve this goal (Blackwell et al. 1998, Minnis 2011). It seems plausible that under nonmandatory auditing, before extending credit limit the main debt holders of a financially distressed small firm will require the opinion of a high-quality professional auditor on whether the company is a going concern and whether the financial statements reflect a true and fair view of the financial performance and position of the company in question. To summarize, we hypothesise the following:
H4: Ceteris paribus, non-mandatory audit is positively associated with financial distress.
19
4. Data and models 4.1. Data The data for the empirical tests come from three sources. First, we employ data gathered from a questionnaire survey of the decisions of owner-managers to voluntarily hire an auditor, coupled with their perceptions of the importance of auditing and accounting services as well as information on other relevant attributes of the company. Because our hypotheses (H3 and H4) focus on how a qualified audit report and a company’s financial distress affect demand for voluntary auditing, we also need data on the financial statements and audit reports of the sample companies. Hence, the survey data were complemented with data from Finnish Company Register (Kaupparekisteri) and from Suomen Asiakastieto Oy, the leading business and credit information company in Finland. The survey was a part of a larger study commissioned by (then) Ministry of Trade and Industry of Finland that aimed at examining potential economic consequences and changes in auditing markets of different proposed scenarios of changes in auditing requirements (MTI 2006). The survey was conducted in November and December 2005 and it was directed to small companies that were likely to be influenced by the forthcoming changes in auditing requirements (see footnote 3). The random sample of 5,000 small companies with an email address and with no more than 10 employees was drawn out of 88,000 firms in the member register of The Federation of Finnish Enterprises. From that list accounting and auditing firms were deleted leaving a final list of 4,827 small limited liability companies. The survey was an Internet questionnaire. Each owner-manager received a personal mail to the email address that he or she had given to the Federation for correspondence between the member entrepreneur and the Federation. It was not
20
possible to answer more than once. As the target population of the survey comprised owner-managers of small companies, forwarding the Internet link of the questionnaire to another recipient was made impossible. The email link to the questionnaire was sent to the targets twice and 412 useable responses were received, giving a response rate of 8.5%. We describe the sample in more detail in section 5.1 and examine the sample adequacy in section 5.3.5. To avoid a self-selection bias in a study examining drivers of voluntary audit, it is preferable that respondents in the survey have experience of the potential benefits of the audit.13 All respondents in our study had a financial statement audit because at the time the survey was conducted, all companies in Finland, regardless of size, were required to have an audit. The respondents also knew that they may not need to have an audit in the near future due to the anticipated changes in the audit requirements for small companies. The respondents’ experience of being audited is of particular relevance in testing our hypothesis that prior conflicts between the auditor and the client arising from qualified audit reports may reduce the latter’s willingness to have an audit in the future. Clearly, conflicts with the auditor are not possible without an audit. Unlike the UK, where small companies have been exempted from mandatory audit since 1994 (Collis et al., 2004, p. 87), we are able to test the significance of this factor in our institutional setting.
4.2. Models To test our hypotheses, we first employ a set of binary logit regressions where the dependent variable takes the value of 1 if the responding owner-manager has answered ‘Yes’ to the question “If auditing were voluntary for your company, but the choice of a non-certified auditor was not allowed, would you hire an auditor?”, and 0 if the answer to this question is ‘No’. 14
21
In addition, we employ a set of multinomial logit regressions that allow us to examine simultaneously not only those responding ‘Yes’ or ‘No’ to voluntary audit but also those who had no clear opinion (we have grouped those answers as ‘Maybe’). The benefit from a multinomial regression is that it provides a more complete picture of owner-managers’ perceptions and the drivers of them because more alternative values of the dependent response variable are considered. Moreover, this approach increases our sample size because the firms responding ‘Maybe’ can also be included in the empirical tests. In order to assess the robustness of Collis et al. (2004) study, we follow their choice and definitions of variables as close as possible in building our ‘Benchmark Model’ (see the variables LNTOVER, BANK, FAMILY, CHECK, QUALITY, and EDUCATN defined below). To test our hypotheses, we augment the ‘Benchmark Model’ with four test variables (OUTSOURCED, TAXADVICE, QUALIFIED, and DISTRESS defined below). Hence, our complete empirical logistic regression model (labelled ‘Hypothesised Model’) is the following:
1 1 e
Prob( NMAUDITi )
where
Z
0 5
1
LNTOVERi
QUALITYi
TAXADVICEi
8
6
(1)
Z
2
BANK i
EDUCATN i 9
3 7
QUALIFIEDi
FAMILYi
4
CHECK i
OUTSOURCEDi 10
DISTRESSi
i
The dependent variable is the probability of non-mandatory audit, NMAUDIT. The variable has three categories: 2 = ’Yes’, 1 = ’Maybe’ and 0 = ’No’. We provide binary logistic regressions using categories ‘Yes’ and ‘No’ and multinomial logistic regressions using the three response categories (‘Yes’, ‘Maybe’, and ‘No’).
22
LNTOVER is the size of company as measured by a natural logarithm of turnover (in euros). BANK is a dichotomous indicator variable with the value of 1 if the company uses outside (bank) financing, and 0 otherwise. FAMILY is a dichotomous indicator variable receiving the value of 1 if the owner is actively involved in running of the business and 0 otherwise. CHECK is the extent of agreement that the audit provides a check on internal books/records (1 = disagree, 5 = agree). QUALITY is the extent of agreement that the audit improves the quality of financial statement information (1 = disagree, 5 = agree).15 EDUCATN is management's awareness of the costs and benefits of the audit (1 = low, 3 = high).16 OUTSOURCED describes the extent of agreement that financial accounting services (such as bookkeeping, preparation of financial statements, accounting for the payroll etc.,) provided by the external accountant to the company are important (1 = disagree, 5 = agree). TAXADVICE describes the extent of agreement that tax advisory services provided by the external accountant to the company are important (1 = disagree, 5 = agree). QUALIFIED is a dichotomous variable with the value 1 if in any of the years 20012005 the firm has a qualified audit report and the reasons for the qualified report refer to the owner-manager rather than to the external accountant and 0 otherwise. DISTRESS is the Z-score value for (high values) predicting bankruptcy. 17 For each sample firm, the Z-score is calculated from the most recent financial statements available at the time of the questionnaire survey.
23
5. Results 5.1. Descriptive statistics We form three groups of respondents based on their attitudes towards voluntary audit: those that are willing to incur voluntary audit (n = 248), firms that might incur voluntary audit (n = 101), and firms that do not want to have an audit if voluntary (n = 63). Thus, in our sample 60% (= 248/412) of the firms would choose to have their accounts audited if they were exempt, which is surprisingly similar to the corresponding proportion of 63% in the UK (Collis et al., 2004). In Table 1 we report the descriptive statistics of our data. The results of the t-tests comparing the three groups of respondents with respect to each continuous variable are shown in Panel A of Table 1. We also report the non-parametric Mann-Whitney U-test for the equality of the medians of the three groups. The U-test is preferred in the case of skewed distributions of the underlying variables. The dichotomous variables and their relative frequencies (i.e., mean values) are shown in Panel B of Table 1. To compare the frequencies of the firms with different attitudes to voluntary audit, we use Fisher’s exact test, which is more accurate than the conventional
2
-test especially if the proportions are close to 0 or 1.
In all of the variables considered in the ‘Benchmark Model’ (LNTOVER, CHECK and QUALITY) except EDUCATN, the t-test shows a statistically significant difference in the means of the firms that are willing to incur a voluntary audit compared with those that are not. Of the hypotheses variables (OUTSOURCED, TAXADVICE, QUALIFIED, DISTRESS) only OUTSOURCED is significant in the ttest at conventional confidence levels, indicating that firms willing to incur a voluntary audit also perceive higher importance of external financial accounting services.
24
The group of companies responding ‘Maybe’ to the question concerning their willingness to engage in non-mandatory auditing shows similar differences as the group ‘No’ when compared to the group “Yes” in all of the variables considered in the benchmark model (LNTOVER, CHECK, QUALITY, EDUCATN) and also in two hypotheses variables OUTSOURCED and TAXADVICE. However, when ’Maybe’ and ‘No’ groups are compared, three benchmark variables (LNTOVER, CHECK, and EDUCATN) are statistically different across the groups in the t-tests and U-tests. Overall, the p-values suggest that the group ‘Maybe’ is more similar to the ‘No’ group than the ‘Yes’ group in terms of the statistics reported in Panel A of Table 1.
[Table 1 about here]
Panel B of Table 1 shows that the proportion of bank financing is more common in the group in which owner-managers are willing to voluntarily hire an auditor than in the group in which owner-managers are not willing to voluntarily hire an auditor. There is statistically no significant difference between these two groups with respect to family-ownership. Similarly, neither groups ‘Yes’ versus ‘Maybe’ nor ‘Maybe’ versus ‘No’ differ significantly from each other with respect to the variables BANK and FAMILY. Consistent with H2, the variable QUALIFIED obtains the highest value of 0.190 when owner-managers do not want to incur a voluntary audit, that is, in the group ‘No’. Fisher’s exact tests show that uncertain owner-managers with respect to a voluntary audit (that is, ‘Maybe’ group), differ at p-level of 0.091 from both ‘Yes’ and ‘No’ groups.
25
5.2. Correlations We provide two correlation matrices. Panel A of Table 2 reports Pearson (below the diagonal) and Spearman (above the diagonal) correlations for the binary model (‘Yes’ and ‘No’ responses only) and Panel B of Table 2 reports the corresponding correlation matrices for the data that also include ‘Maybe’ responses to client’s willingness to hire an auditor voluntarily. Panel A of Table 2 allows for comparability with Collis et al. (2004). It shows that while the benchmark variables LNTOVER, BANK, CHECK and QUALITY are positively correlated with the client’s willingness to hire an auditor voluntarily, FAMILY and EDUCATN have insignificant correlations. Consistent with our prediction, OUTSOURCED is positively correlated with the client’s willingness to hire an auditor voluntarily. The correlations estimated for other hypotheses variables (TAXADVICE, QUALIFIED and DISTRESS) are insignificant. Panel B of Table 2 enables an examination of the underlying covariance structure of multinomial tests. The correlations between the client’s willingness to hire an auditor voluntarily and other variables are largely similar to Panel A except that EDUCATN now has an expected positive correlation with the willingness to engage in non-mandatory audits.18
[Table 2 about here]
5.3. Regression results 5.3.1. Binary logistic regressions The results of the binary logistic models are shown in Table 3. To make a comparison to prior empirical evidence, we show also the empirical results reported by Collis et
26
al. (2004, Table 7, p. 96) in the table. Overall, the fit of our ‘Benchmark Model’ is close to the original model of Collis et al. (2004). Both models are very significant at p < 0.001. The coefficient of determination measured by pseudo-R2 is 29.0% which is only slightly lower than the corresponding statistic (34.8%) reported by Collis et al. (2004). In our sample, the coefficients of other variables obtain predicted signs and are significant, except FAMILY and EDUCATN. For FAMILY, the lack of significance may relate to the fact that there is little variance in it (see Table 1 Panel B). Overall, our ‘Benchmark Model’ provides empirical evidence of the robustness of the findings documented by Collis et al. (2004) from the UK. In spite of the regulatory differences between the two countries, we can conclude that small companies in the UK and Finland have many similar drivers of demand for non-mandatory audits. The ‘Hypothesised Model’ reported in Table 3 includes four additional variables (OUTSOURCED, TAXADVICE, QUALIFIED and DISTRESS). The estimated model provides expected empirical evidence for two of our hypotheses variables, OUTSOURCED and TAXADVICE. The positive coefficient of OUTSOURCED (with p-value 0.019) suggests that financial accounting services provided by an external accountant increase demand for voluntary audits. The negative coefficient documented for TAXADVICE (with p-value 0.026) provides evidence that the tax advisory services of external accountants reduce demand for voluntary audits. It suggests that, at least under our regulatory setting with a high degree of alignment between financial and tax reporting, external accountants may assume a larger role as tax advisors of small firms if firms are exempt from mandatory auditing. Because one of the primary roles of financial statements in our setting is to satisfy the information needs of tax authorities, it may be cost-efficient to use tax advisory services offered by those preparing the financial statements instead
27
of those auditing them. Finally, it is noteworthy that, contrary to our expectation, we do not find any significant impact for the QUALIFIED and DISTRESS variables in these binary logistic regressions.
[Table 3 about here]
5.3.2. Multinomial logistic regressions Table 4 presents results from the multinomial logit regressions. The categorical values of the dependent variable are ‘No’, ‘Maybe’ and ‘Yes’. In accordance with binary regressions (Table 3), the reference category is ‘No’. For each independent variable Table 4 compares the willingness (‘Yes’) and potential willingness (‘Maybe’) to incur voluntary audit to the willingness not to hire an auditor voluntarily (‘No’). Hence, the results of multinomial logit regression enable examination of attitudes of uncertain respondents towards voluntary audits. The ‘Benchmark Model’ and ‘Hypothesised Model’ in Table 4 are consistent with the descriptive data because firms willing to hire an auditor voluntarily (‘Yes’) differ more clearly from those who are not (‘No’), compared to the corresponding difference to uncertain respondents (‘Maybe’). This can be seen from the clearly significant coefficients
of
‘Yes’-category
for
LNTOVER,
CHECK,
QUALITY
and
OUTSOURCED. Also those undecided differ to some extent from those saying ‘No’ to voluntary audit as significant coefficients of LNTOVER, CHECK, QUALIFIED and DISTRESS variables in the category ‘Maybe’ show. The negative sign for QUALIFIED (with p-value 0.074) in the ‘Maybe’-category means that receiving a qualified report reduces the willingness to hire an auditor among those who are undecided about whether to have an audit. We cannot find any impact of QUALIFIED when comparing the ‘Yes’- and ‘No’- categories. The positive sign for DISTRESS
28
(with p-value 0.098) in the ‘Maybe’-category means that the willingness to incur voluntary audit increases with the likelihood of bankruptcy for those who are undecided. We cannot find any impact of DISTRESS when comparing the ‘Yes’- and ‘No’- categories. Consistent with the results from our binary logit regression, OUTSOURCED in the multinomial logit regression provides support for the hypothesis that financial accounting services provided by an external accountant increase demand for voluntary audits (H1). In our multinomial regression, QUALIFIED and DISTRESS provide some support for our hypotheses that a qualified audit report has a negative effect on the demand for non-mandatory audits (H3) whereas the willingness to have a nonmandatory audit increases with financial distress (H4).
[Table 4 about here]
5.3.3. Additional tests of the impact of financial distress. It may be that the relationship of our measure of financial distress (Z score) and audit choice is not monotonic. We perform several additional tests to address this specification problem. First, as the cost of voluntary audits may play a crucial role for small companies that are experiencing serious financial distress, these firms could be expected to refrain from non-mandatory audits simply because they cannot afford it. Consequently, we could expect a negative association between serious financial distress and the firm’s willingness to engage in non-mandatory audit for these firms. In order to test this negative association, we examine the most distressed firms at the top 5, 10, and 20 percentiles of our sample separately. However, we are unable to find
29
the expected negative association for these highly distressed firms because the Zstatistic measuring this effect remains insignificant in these additional tests. Second, we also consider the possibility that the slope coefficient of the DISTRESS variable differs systematically between small companies that are family- owned and those that are not. This could be the case if companies with more dispersed ownership and separation of ownership and control face more demands (from outside shareholders) to hire an independent auditor under a high level of financial distress. To account for this possibility, we augment our regressions with the interaction variable FAMILY x DISTRESS, but once again the tests do not yield significant results. Moreover, to capture different dimensions of financial problems we also examine two alternative empirical measures of financial distress. The two measures employ data provided by Suomen Asiakastieto Oy. The first measure is ‘Alfa Rating’ measuring the credit default risk of the sample of small companies. In line with the well-known international rating agencies (such as Standard & Poor’s, and Dun & Bradstreet), ‘Alfa Rating’ is based on a large set of background information about the sample companies, such as firm age, the credit history of its key personnel, financial statement information, and the credit default history of the firm itself. In addition, we construct a dichotomous indicator variable with a value of 1 if the firm had experienced credit defaults during the last five years and 0 otherwise. However, these two alternative proxies of financial distress also yield insignificant results, thereby providing no additional support for our ‘financial distress’ hypothesis.
30
5.3.4. Tests on common drivers of external accounting and auditing To examine the possibility of endogeneity due to the demand for external accounting services and voluntary audit being collinear and driven by the same factors (cf. hypothesis H1), we regress OUTSOURCED (measuring the demand for external accounting) on the independent variables used in our model predicting non-mandatory audit, NMAUDIT (measuring the demand for voluntary audit). The results from these regressions are shown in Table 5 where we provide two external accounting models and an abridged voluntary auditing model for comparison (the corresponding full model appears in Table 3).
[Table 5 about here]
In brief, the estimated regression coefficients and their confidence levels do not give grounds to suspect that our primary results reported in Tables 3 and 4 are driven by endogeneity to any significant extent. On the contrary, low pseudo-R 2 of the two external accounting models (0.019 and 0.032, respectively) and insignificant regression coefficients (except that for BANK) suggest that the demand for external accounting is not determined by the same factors as the demand for voluntary audit. In addition, to account for the possibility that there is a common variable omitted from regressions reported in Table 5 driving the need for an external accountant and the need for an audit, we estimate the correlations between the residuals of these regressions. In case of an important omitted variable, a high correlation between the residuals can be expected. Our results from this analysis indicate, however, that the correlation is close to zero and far from being significant. For example, the Pearson (Spearman) correlation between the residuals from the ‘Non-mandatory audit’ and the
31
‘External accounting’ models with three independent variables is only 0.006 (0.066) with p-value of 0.917 (0.245). Taken together, our tests do not suggest that the demand for external accounting services and voluntary audit are collinear and driven by the same factors.
5.3.5. Tests on sample adequacy Finally, we examine the generalisability of our empirical findings. We first test if the size distribution of our sample differs from the population of small Finnish firms. To this end, we retrieve all (approximately 69,000) Finnish small companies available from the Amadeus data base provided by Bureau van Dijk.19 Using the KolmogorovSmirnov test and Kuiper asymptotic two-sample test (untabulated), we find that the size (sales) distributions of our sample vis-à-vis the population of Finnish small companies on the database are not different on conventional confidence levels. In addition, we address potential non-response bias in two ways. First, using late responses as proxies for non-respondents, we augment our hypothesised model (see Table 3) with DAYS ELAPSED, which measures the number of days elapsed before respondents returned the survey questionnaire. 20 Untabulated results show that the regression coefficient of DAYS ELAPSED is non-significant and other coefficients of the hypothesised model are not qualitatively affected by the inclusion of DAYS ELAPSED. Finally, we partition the sample using DAYS ELAPSED from the median observation into early and late respondents. Using chi-squared test (untabulated) we find no evidence that the distributions of ‘yes’ and ‘no’ responses to voluntary audit differ across the subsamples. In conclusion, we do not find sufficient grounds to suspect that our findings are affected by our sample being biased to any significant extent.
32
6. Conclusions This study examines the drivers of the demand for voluntary audit in privately held small companies. Using a sample of 412 small companies in Finland, we first explore the institutional boundaries of the findings reported by Collis et al. (2004) from the UK to see whether their findings also apply to a setting typical of many Continental European countries such as Belgium, France, Germany, Italy and Sweden. The similarity of our findings to Collis et al. (2004) are in line with the view that factors relating to firm size, outside (bank) financing, the need to provide a check on internal controls and to improve the quality of financial statement information are robust drivers of demand for voluntary audits among small companies in different regulatory settings. In addition to the factors examined in prior related literature, we argue that small companies have some other characteristics that have an impact on the decision to voluntarily hire an auditor. We report results consistent with the view that outsourcing accounting functions to an external accountant creates an agency-type contracting relationship between the owner-manager and the accountant, thereby increasing the need for an audit. In contrast, companies that consider tax advisory services from an external accountant beneficial are less likely to hire an auditor if the audit is nonmandatory. This is consistent with the view that, at least in an environment where taxation is essentially based on financial reports, the availability of competitive and cost-efficient tax advisory services from an external accountant reduces the incentive to hire an auditor. We also hypothesise and find evidence indicating that prior conflicts attributable to qualified audit reports may reduce the willingness to hire an auditor. Our regulatory
33
setting where all companies have been required to have a financial statement audit, coupled with the anticipated future exemption from audit for small companies, is particularly appropriate for testing the impact of qualified audit reports on the decision to continue to hire an auditor. Finally, we hypothesise and find evidence indicating that financially distressed companies are more likely to hire an auditor. This falls in line with the view of professional advice from an auditor being useful for a financially distressed client. The findings from this study should be considered in conjunction with its limitations. First, our measure of willingness to choose voluntary auditing is based on expected behaviour (intent) rather than actual decision to hire an auditor. There are, however, no obvious reasons why an intent to hire an auditor would systematically differ from the actual decision thereby biasing our results. Nevertheless, this limitation should be kept in mind when interpreting our findings. Second, we find evidence supporting our hypotheses regarding the impact of qualified opinions and financial distress only between respondents who are undecided (‘Maybe’) and negative (‘No’) towards voluntary audit. In other words, we are unable to document that qualified opinions and financial distress affect opinions of those who are willing (‘Yes’) to hire an auditor. Moreover, the statistical significance of these results is somewhat low. Even so, our findings indicate that having a qualified opinion (financial distress) may reduce (increase) the willingness to have an audit. Finally, an alternative explanation for the association found between voluntary audit and perceived importance of the services provided by an external accountant could be due to the external accountant knowing the business well and using his/her experience to explain the benefits of having the accounts audited. If this were the case, the use of voluntary audit and external accounting services would be collinear
34
and driven by the same factors. However, the results of our additional tests do not support this explanation. In addition, our unique case evidence suggests the existence of an information asymmetry problem (moral hazard) in the relationship between the owner-manager and the external accountant. Overall, the results of this study have implications for regulators in different countries considering factors influencing the demand for and supply of auditing services under non-mandatory auditing. For instance, the findings have implications when (if) adopting and enforcing IFRS for SMEs in different jurisdictions. If these accounting standards decrease (or even ‘break’) the alignment between financial and tax accounting especially in jurisdictions where this alignment has traditionally been strong (i.e., most Continental Europe countries), the findings documented in this study suggest that the adoption of IFRS by small companies may result in an increase in the demand for non-mandatory audits among these firms. This is the case because the competitive advantage attributable to the cost-efficiency possessed by external accountants in providing tax advisory services to their clients can be expected to decrease to some extent when the link between financial statements and firm taxation weakens under IFRS. These implications are relevant in the light of the European Commission’s initiative to reduce administrative burdens placed on SMEs (European Commission, 2007a, 2007b; 2010, pp. 18-19).
35
References Abdel-Khalik, A.R., 1993. Why do private companies demand auditing? A case for organizational loss of control. Journal of accounting, auditing and finance, (Winter), 31–52. Alford, A., Jones, J., Leftwich, R. and Zmijewski, M., 1993. The relative informativeness of accounting disclosures in different countries. Journal of accounting research, 31(Supplement), 183–223. Ali, A. and Hwang, L-S., 2000. Country-specific factors related to financial reporting and the value relevance of accounting data. Journal of accounting research, 38 (1), 121. Altman, E.I., 1968. Financial ratios, discriminant analyses and the prediction of corporate bankruptcy. The Journal of finance, 23 (4), 589–609. Anderson, D., Francis, J.R. and Stokes, D.J., 1993. Auditing, directorships and the demand for monitoring. Journal of accounting and public policy, 12, 353–375. Bahli, B. and Rivard, S., 2003. The information technology outsourcing risk: a transaction cost and agency theory-based perspective. Journal of information technology, 18, 211–221. Baker, C.R., Mikol, A. and Quick, R., 2001. Regulation of the statutory auditor in the European Union: a comparative survey of the United Kingdom, France and Germany. European accounting review, 10 (4), 763–86. Bame-Aldred, C.W. and Kida, T., 2007. A comparison of auditor and client initial negotiation positions and tactics. Accounting, organizations and society, 32, 497–511. Beattie, V., Fearnley, S. and Brandt, R., 2000. Behind the audit report: a descriptive study of discussions and negotiations between auditors and directors. International journal of auditing, 4, 177–202. Beattie, V., Fearnley, S. and Brandt, R., 2004. A grounded theory model of auditorclient negotiations. International journal of auditing, 8, 1–19. Bennett, R.J. and Robson, P.J.A., 1999. The use of external business advice by SMEs in Britain. Entrepreneurship and regional development, 11, 155–180. Benston, G.J., 1985. The market for public accounting services: demand, supply and regulation. Journal of accounting and public policy, 4, 33–79. Blackburn, E., Eadson, W. Leebvre, R. And Gans, P., 2006. SMEs, regulation and the role of the accountant. ACCA research report no. 96. London: Certified accountants educational trust.
36
Blackburn, R., Carey, P. and Tanewski, G.A. 2010. Business advice to SMEs: professional competence, trust and ethics. ACCA research report no. 119. London: Certified accountants educational trust. Blackwell, D.W., Noland, T.R. and Winters, D.B., 1998. The value of auditor assurance: evidence from loan pricing. Journal of accounting research, 36, 57 – 70. Carcello, J.V. and Neal, T.L., 2003. Audit committee characteristics and auditor dismissals following “new” going-concern reports. The Accounting review, 78 (1), 95–117. Carey, P., Simnett, R. and Tanewski, G., 2000. Voluntary demand for internal and external auditing by family businesses. Auditing: a journal of practice & theory, 19 (Supplement), 37–51. Cassar, G. and Ittner, C.D., 2009. Initial retention of external accountants in startup ventures. European accounting review, 18 (2), 313–340. Chow, C.W., 1982. The demand for external auditing: size, debt and ownership influences. The Accounting review, 57 (2), 272–291. Chow, C.W. and Rice, S.J., 1982. Qualified audit opinion and auditor switching. The Accounting review, 57 (2), 326–334. Chung, S. and Narasimhan, R., 2001. Perceived value of mandatory audits of small Companies. Managerial auditing journal, 16 (3), 120–123. Cloyd, B., Pratt, J. and Stock, T., 1996. The use of financial accounting choice to support aggressive tax positions: public and private firms. Journal of accounting research, 34 (1), 123–143. Collis, J., 2008. Directors’ views on accounting and auditing requirements for SMEs. The Department of business, enterprise and regulatory reform, UK. Collis, J., Jarvis, R. and Skerratt, L., 2004. The demand for the audit in small companies in the UK. Accounting and business research, 34 (2), 87–100. Craswell, A.T., 1988. The association between qualified opinions and auditor switches. Accounting and business research, 19 (73), 23–31. DeFond, M.L., 1992. The association between changes in client firm agency costs and auditor switching. Auditing: a journal of practice & theory, 11 (Spring), 16–31. European Commission, 1996. Green paper: the role, the position and the liability of the statutory auditor within the European Union. Commission of the European Communities, Brussels. 1998. Communication from the Commission: the statutory audit in the European Union: the way forward. Commission of the European Communities, Brussels.
37
2000. Commission recommendation: quality assurance for the statutory audit in the EU: minimum requirement. Commission of the European Communities, Brussels. 2003. Communication from the Commission: reinforcing the statutory audit in the European Union. Commission of the European Communities, Brussels. 2007a. Communication from the Commission on a simplified business environment for companies in the areas of company law, accounting and auditing. Commission of the European Communities, Brussels. 2007b. Synthesis of the reactions received to the Commission communication on a simplified business environment for companies in the areas of company law, accounting and auditing. Commission of the European Communities, Brussels. 2010. Audit policy: lessons from the crisis (Green paper). Commission of the European Communities, Brussels. Fama, E.F., 1980. Agency problems and the theory of the firm. Journal of political economy, 88 (2), 288–307. Francis, J.R. and Wilson, E.R., 1988. Auditor changes: a joint test of theories relating to agency costs and auditor differentiation. Accounting review, 63 (4), 663–682. Gibbins, M., Salterio, S. and Webb, A., 2001. Evidence about auditor-client management negotiation concerning client’s financial reporting. Journal of accounting research, 39 (3), 535–563. Gooderham, P.N., Tobiassen, A., Doving, E and Nordhaug, O., 2004. Accountants as sources of business advice for small firms. International small business journal, 22 (1), 5–22. Hay, D. and Davis, D., 2004. The voluntary choice of an audit of any level of quality. Auditing: a journal of practice and theory, 23 (September), 37–53. Holmström, B., 1979. Moral hazard and observability. Bell journal of economics, Spring, 74–91. Jaggi, B. and Low, P.Y., 2000. Impact of culture, market forces, and legal system on financial disclosures. International journal of accounting, 35 (4), 495–519. Jarvis, R. and Rigby, M., 2010. Business advice to SMEs: human resources and employment. ACCA research report no. 123. London: Certified accountants educational trust. Jensen, M. and Meckling, W., 1976. Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of financial economics, 3 (4), 305–360.
38
Johnstone, K.M., Bedard, J.C. and Biggs, S.F., 2002. Aggressive client reporting: factors affecting auditors’ generation of financial reporting alternatives. Auditing: a journal of practice & theory, 21 (1), 47–65. Kim, J-B., Simunic, D.A., Stein, M.T. and Yi, C.H., 2007. Voluntary audits and the cost of debt capital for privately held firms: Korean evidence. Unpublished working paper. University of British Columbia. Knechel, W.R., Niemi, L. and Sundgren, S., 2008. Determinants of auditor choice: evidence from a small client market. International journal of auditing, 12, 65–88. Laitinen, E.K. and Laitinen, T., 2004. Yrityksen rahoituskriisin ennustaminen. (Predicting financial distress of a firm, in Finnish). Jyväskylä: Talentum Media Oy. LaPorta, R., Lopez-de-Silanes, F., Shleifer, F.A. and Vishny R.W. 1998. Law and finance. Journal of political economy, 106, 1113–1155. Lennox, C., 2000. Do companies successfully engage in opinion-shopping? Evidence from the UK. Journal of accounting and economics, 29 (3), 321–337. Leung, P., Raar, J. and Tangely, G., 2008. Accounting services and SME:s An Australian study. ACCA research report 99. London: Certified accountants educational trust. Margerison, J. and Moizer, P., 1996. Auditor licensing in the European Union: a comparative study based on cultural differences. European accounting review, 5 (1), 29–56. Minnis, M., 2011. The value of financial statement verification in debt financing: evidence from private U.S. firms. Journal of accounting research, 49 (2), 457–506. Mohr, J. and Spekman R., 1994. Characteristics of partner success: partnership attributes, communication behaviour, and conflict resolution techniques. Strategic management journal, 15 (2), 135–152. MTI, 2006. Financial impact of amending the auditing obligation. MTI Financed Studies, 2/2006. Ministry of Trade and Industry. Helsinki: Edita Publising Oy. Niemi, L., 2002. Do firms pay for audit risk? Evidence on risk premiums in audit fees after direct control for audit effort. International journal of auditing, 6 (1), 37–51. Niemi, L., 2004. Auditor size and audit pricing: evidence from small audit firms. European accounting review, 13 (3), 541–560. Niemi, L. and Sundgren, S., 2008. Developments in auditing regulation in Finland in Auditing, trust & governance – regulation in Europe. (eds. Quick, R., S. Turley, and M. Willekens). London: Routledge.
39
Niskanen, M., Karjalainen, J. and Niskanen J., 2011. Demand for audit quality in private firms: evidence on ownership effects. International journal of auditing, 15 (1), 43–65. Nobes, C.W., 1983. A judgmental international classification of financial reporting practices. Journal of business, finance & accounting, 10 (1), 1–19. Nobes, C.W. and Parker, R., 2008. Comparative international accounting. 10th ed. Harlow: Prentice Hall, Pearson Education Limited. Patel, C., Harrison, G.L. and McKinnon, J.L., 2002. Cultural influences on judgements of professional accountants in auditor-client conflict resolution. Journal of international financial management and accounting, 13 (1), 1–31. Pittman, J.A. and Fortin, S., 2004. Auditor choice and the cost of debt capital for new public firms. Journal of accounting research, 37, 113–136. Poutziouris, P., Chittenden, F. and Michaelas, N., 1999. Evidence on the tax and investment affairs of small firms. Journal of small business and enterprise development, 6 (1), 7–25. Roe, M.J., 2005. The institutions of corporate governance. In: Handbook of new institutional economics, ed. by Claude Ménard and Mary M. Shirley. The Netherlands: Springer. Scott, W.R., 2009. Financial accounting theory. 5th ed. Toronto, Ontario: Pearson Canada Inc. Simunic, D.A. and Stein, M.T., 1987. Product differentiation in auditing: auditor choice in the market for unseasoned new issues. Vancouver, BC: The Canadian certified general accountants’ research foundation. Syrjä, P., 2010. Pienten osakeyhtiöiden verosuunnittelu – empiirinen tutkimus. (Tax planning in small private companies – empirical research, in English). Thesis (PhD). Acta Universitatis Lappeenrantaensis 381. Lappeenranta University of Technology. Taylor, M.H., and Simon, D.T., 1999. Determinants of audit fees: the importance of litigations, disclosure, and regulatory burdens in audit engagements in 20 countries. The International journal of accounting, 34 (3), 375–388. Tsui, J.S.L. and Gul, F.A., 1996. Auditors’ behaviour in an audit conflict situation: a research note on the role of locus of control and ethical reasoning. Accounting organization and society, 21 (1), 41–51. Van Peursem, K.A. and Wells, P.K., 2000. Contracting practices in professional accounting SMEs: an analysis of New Zealand firms. International small business journal, 19 (1), 68–82.
40
Van Tendeloo, B. and Vanstraelen, A., 2008. Earnings management and audit quality in Europe: evidence from the private client segment market. European accounting review, 17 (3), 447–469. Wallace, W.A., 2004. The economic role of auditing in free and regulated markets – a look back and a look forward. Research in accounting regulation, 17, 267–298. Watts, R.L. and Zimmerman, J.L., 1986. Positive accounting theory. Englewood Cliffs, NJ: Prentice-Hall. Willekens, M., 2008. The role of external auditing in private companies. Unpublished working paper. Katholieke Universiteit Leuven. Willenborg, M., 1999. Empirical analysis of the economic demand for auditing in the initial public offerings market. Journal of accounting research, 37 (1), 225–238.
41
42
12.770 5.000 4.000 2.500 3.000 4.000 -0.600
Median
'Yes' vs. 'No'
