Audit Quality: The Role of Board Structure in Family Firms

Abstract

This study investigates the role that board structure has on the demand for audit quality in connection with family ownership in a sample of private firms. In addition to this, we also shed light on whether ownership structure and board structure are substitute mechanisms in resolving agency costs in private family firms. Our main results show that the presence of outsiders on the board increases the demand for audit quality in the overall sample as well as in the presence of family ownership. Our results also confirm previous results and indicate that family firms are less likely to engage a Big 4 auditor even when we control for board structure. Additionally, we find that in a subsample of family firms the probability of choosing a Big 4 auditor decreases with an increase in CEO ownership and is higher in firms with outside boards. When we investigate the interaction between CEO ownership and outside boards, we find that role of outside boards is weaker when CEO ownership increases.

Auditor choice in Italian non-listed firms

“…With respect to ownership structure as a key corporate governance mechanism, the existing literature examines whether different ownership types are associated with auditor choice. Given the international prevalence of ownership concentration through family control, the relationship between family control and auditor choice is examined by El Ghoul et al (2007), Francis et al (2009), Niskanen et al (2010) and Niskanen et al (2011aNiskanen et al ( , 2011b. As our sample firms include family firms, we investigate the influence of this ownership structure on the auditor choice.…”

“…First, as it has effective control of the firm and assigns its members to sit either on the board or management team, the controlling family may have greater opportunity for extracting private benefits and lower corporate transparency. Thus, family firms may be reluctant to impose external monitoring and are more likely to engage low-quality auditors to protect the family's private interests (Niskanen et al, 2011a(Niskanen et al, , 2011b. Second, and conversely, family firms are concerned somewhat more than other firms about their long-term survival and reputation, leading them to provide high-quality financial information to maintain investors' confidence (Dey et al, 2011).…”

“…The literature also demonstrates that the choice of an auditor by the smallest (non-listed) firms is driven mostly by firm complexity, that is the need for strengthening internal control (Knechel et al, 2008;Niskanen et al, 2011aNiskanen et al, , 2011b. This means that the higher the complexity of the firm, the greater the need for a high-quality auditor to monitor firm complexity and operations.…”

“…The existing literature concerning auditor choice in non-listed firms (Carey et al, 2000;Chaney et al, 2004;Lennox, 2005;Fortin and Pittman, 2007;Broye and Weill, 2008;Knechel et al, 2008;Niskanen et al, 2011aNiskanen et al, , 2011b shows results that vary across countries, given different legal systems and degrees of investor/stakeholder protection. Our motivation for studying auditor choice in non-listed firms in an Italian setting is as follows.…”

“…Agency theory suggests a link between auditor quality and information asymmetry reduction (Dechow et al, 2010). Auditor choice studies start from the proposition that the demand for high-quality audit arises from the information asymmetry between managers and investors (Carey et al, 2000;Chaney et al, 2004;Broye and Weill, 2008;Niskanen et al, 2011aNiskanen et al, , 2011b. Thus, prior research uses agency theory to at least partially explain auditor choice (Carey et al, 2000).…”