Private companies make the same audit service choices as public companies — for the same reasons — despite being exempt from many financial reporting requirements and regulations, according to new research.
“When you step back and look at it, the private side (of audit services) looks almost 99 percent the same as the public side,” says Dr. Karim Jamal, professor and chairman of the University of Alberta’s accounting program. “There are pure underlying incentives that are shaping these relationships, and adding regulations to the mix often changes nothing.”
Private company demand for audit from a “Big Four” firm is driven from a “variety of agents” such as bankers, management, private equity firms and owners hoping to attract prospective buyers, according to the research paper published last month. When an audit is demanded by other sources — such as a regulator — management becomes ”reluctant” to provide financial statements or chooses a “cheaper” solution.
“Our results indicate that demand for private audits comes from a much wider set of agents than those studied in the accounting literature,” the paper concludes, which is based on interviews with 27 private company CEOs, CFOs and investors. “Desire to access debt and/or equity capital dominate the demand for audit, though customers, suppliers, internal governance demands, and other regulators also seek audited financial statements for private companies.”
The reason there is very little difference between the way private and public companies approach an audit is simple, Professor Jamal argues: Management.
“Management continues its very strong role in the auditor relationship from private company to public company,” Dr. Jamal says. “Private equity investors and banks leave it to management to decide on the auditor and the scope of the audit. And despite Sarbanes-Oxley, audit work remains hugely influenced by management decisions in the public side to attract capital. It’s pure incentives.”
Can regulators change the approach to audit services once a company makes the leap from a private company to a publicly traded firm?
It’s unlikely, Dr. Jamal concludes.
“The are huge economic influences on the backend of a company that shape the audit relationship,” he says. “Regulators don’t usually pay attention to these things.”•