Voluntary Audits versus Mandatory Audits

Abstract

Exploiting a natural experiment in which voluntary audits replace mandatory audits for U.K. private companies, we analyze whether imposing audits suppresses valuable information about the types of companies that would voluntarily choose to be audited. We control for the assurance benefits of auditing to isolate the role signaling plays by focusing on companies that are audited under both regimes. These companies experience no change in audit assurance, although they can now reveal for the first time their desire to be audited. We find that these companies attract upgrades to their credit ratings because they send a positive signal by submitting to an audit when this is no longer legally required. In contrast, companies that dispense with being audited suffer downgrades to their ratings because avoiding an audit sends a negative signal and removes its assurance value. Data Availability: All data are available from public sources.

The timeliness of UK private company financial reporting: Regulatory and economic influences

“…Experian, 2013;Kilsby and Williams LLP, 2011), together with that provided by Companies House (CH, 2009, p.7), is that late filing of accounts may result in inferior credit ratings. Since credit ratings may influence the cost and availability of debt finance, building on extant research (Lennox and Pittman, 2011;Dedman and Kausar, 2012), a natural extension of the current study would be to examine the effects of late filing on credit ratings. A further research extension would be to examine whether UK SMEs exercising the option (under the Companies Act) of withholding profit and loss data 34 (see Dedman and Lennox, 2009) exhibit differential reporting lag behaviour.…”

The Demand for Audit in Private Firms: Recent Large-Sample Evidence from the UK

“…Researchers examining this issue using UK data do not focus on interest rates, but on a publicly available credit rating, the QuiScore. Lennox and Pittman (2011) point to problems with trying to construct a measure of interest rates using UK data, while Dedman and Kausar (2012) argue that, as loans are not necessarily renegotiated annually, the QuiScore provides a more responsive measure of the effect of choosing a voluntary audit. This strand of research resonates with the assertion that the audit provides valuable protection to creditors (Leigh, 1968).…”

“…The public good element of the service is one of the justifications employed by the many regulators that mandate audits as a condition of stock exchange listing. It is argued that, absent regulation, there may be under-provision of audit resulting in a social loss (Rennie et al, 2003;Lennox and Pittman, 2011). 1 However, large-scale evidence on the incentives to voluntarily purchase an audit has hitherto been unavailable.…”

Small is big! The role of ‘small’ audits for studying the audit market

“…First, they may alleviate information uncertainty faced by lenders; second, the assurance provided by an audit may reduce debt monitoring and negotiation costs (Blackwell, Noland, & Winters, 1998;Kim et al, 2011). Empirical research from Korea, the United Kingdom (UK) and the USA supports these arguments (Blackwell, Noland, & Winters, 1998;Minnis, 2011;Kim et al, 2011;Lennox & Pittman, 2011;Dedman & Kausar, 2012;Kausar, Shro , & White, 2016). Hope, omas and Vyas (2011), using a 68-country sample, nd similar results.…”

“…Prior research has examined companies' reaction to changes in the regulatory regime, to better understand the bene ts of voluntary audits (e.g. Lennox & Pittman, 2011;Kausar, Shro , & White, 2016). Further research on threshold changes, exempting certain companies from mandatory audits, may contribute to current debate on the costs and bene ts of auditing SMEs.…”