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However, the correlated omitted variable problem deserves more attention in private firm research than in public firm research because the impact is likely to be more severe.13 An example is that the importance of heterogeneity in ownership and governance structures are often neglected, which raises the possibility that effects ascribed to test variables might disappear when adequate controls are included.

A substantial subset of private firms is controlled by families.14 Family firms may have fewer internal agency problems than others because kinship and marriage align goals and incentives between managers and owners, but there are other differences. In their review article, Stewart and Hitt (2012) sort the differences between family and non-family firms into eight categories: ownership, governance, returns, rewards, networks, leadership, careers and management. For instance, family firms might differ from non-family firms “in their capacity to develop and leverage intangible assets such as social capital, trust, reputation, and tacit knowledge”, and “[e]conomic and financial performance may be compromised in preference for creating and preserving types of socioemotional wealth (SMW) such as perpetuating family name, values, control, and employment, or supporting a desirable lifestyle” (Sharma and Carney 2012: 233). For such reasons, significant differences exist between family and non-family firms, and the family effect correlates with variables typically included in the tests such as size, growth and profitability, even though the results are mixed (Steward and Hitt 2012). More importantly, family variables are likely to correlate with the test variables used in audit research. For instance, the choice of a Big N auditor might correlate with family control because of less need to hire a Big N auditor due to fewer internal agency conflicts in family firms; the interest expenses might be lower in family firms because families obtain better terms due to long-lasting relationship with the bank or higher willingness to use private wealth as collateral; and family firms might exhibit higher earnings quality because family owners fear that questionable accounting choices will damage the good name of the family if revealed to the public.

Thus, there are reasons to expect systematic correlations between family variables usually not included in the tests and the variables that are of primary interest.15 The best solution to the omitted variable problem is to incorporate the relevant variables into the test or to use tests and methods that make the relevant variables redundant.16 If omitted variable problems cannot be avoided, the researchers should acknowledge the limitation and provide a caveat that makes the reader aware of this limitation and also discuss how omitted variables may impact the results.17 Access to data on private firm is an obstacle in many countries – the data is simply not available or not as easily available as the data for public firms. This calls for wider search for available data sources. For instance do banks, credit agencies, tax authorities and other governmental agencies and international organization collect data which should be utilized by researchers? Another option is to collect data through surveys (see Allee and Yohn 2009 for a good example) or field research.

Cooperation with audit firms and regulatory bodies may also give access to data. It may be easier to guarantee anonymity of audit firms and/or clients in the private firm segment compared to the public firm segment because there are many more audit firms and clients to choose from. We encourage greater ingenuity in how to obtain data.


In this paper, we highlight the differences between audits of private and public firms and review and synthesize the relatively sparse empirical evidence on audits of private firms. Compared to audits of public firms, little is known about private companies in general and their auditing choices and the pros and cons of auditing of private firms in particular.

The traditional definition of audit quality is the ability to both discover and report on material misstatements. Existing evidence indicates that auditors take the potential negative effects of agency conflicts in an auditee’s ownership and governance structure into account when they plan and execute the audit program, to ensure that financial statements are free for material misstatements.

To the extent that there is a systematic relationship between provision of non-audit services and audit quality, it seems to be positive, indicating that there is a spillover from provision of non-audit services to auditing. Audit quality seems to increase with client-specific knowledge and partner tenure, but decrease when auditors approach retirement age or when they become too busy (measured by number of assignments). The detrimental effect of being busy at the partner level may not be observable at audit firm level. However, the results indicate that audit quality is more heterogeneous among the smallest audit firms and that audit firms apply different strategies to gain market shares (including meeting the demand for low quality audits in statutory audit regimes).

Contrary to the results for public firms, the apprehension that large audit firms deliver audits of higher quality than small audit firms does not receive unanimous support. Inadequate controls for auditee, audit partner/office/firm and country specific factors and different measures of audit quality may explain part of the mixed results. In short, our interpretation is that most studies indicate that Big N firms are more sophisticated, deliver audits of higher quality and charge higher fees than nonBig N firms, and that the Big N firms’ incentives to deliver audits of higher quality increase with the extent to which the auditee exposes the audit firm to risk.

The benefits of private company audits are multifaceted and vary considerably across companies.

While agency factors are important drivers of voluntary audits and the choice of high quality auditors, there are also other drivers. The evidence suggests that voluntary audit eases access to credits, reduces cost of capital and improves credit ratings and can also to some extent be of internal value to the auditee. Overall, evidence suggests that audits of private companies are valued by users of audited financial statements (among them the management of the auditee is an important user), but whether or not benefits exceed costs is firm-specific.

The private firm setting is different from the more homogeneous public firm segment. This makes it necessary to verify the generalizability of results from public firm studies. Even more importantly, the uniqueness of the private firm setting gives researchers opportunities to investigate questions that cannot be addressed using public firm data. Some of these questions may provide regulators with useful insights, for instance related to provision of non-audit services (no detrimental effect of non audit services has so far been found), the imposition of statutory auditing (which suppresses firms’ abilities to signal their type because they are denied the option of voluntarily engaging an auditor) and the costs and benefits of auditing (none of the studies document cost of debt savings that exceed the direct audit fees paid by the client, and the total costs of auditing is likely to be high).

Thus, by exploiting the particularities of the private firm segment, we believe researchers have great potential for advancing our understanding of the role of auditing.


Abdel-Khalik, A. R., 1993. Why Do Private Companies Demand Auditing? A Case for Organizational Loss of Control. Journal of Accounting, Auditing & Finance, 8(1), pp. 31-52.

Ajona, L.A., F.L. Dallo, and S.S. Alegría, 2008. Discretionary Accruals and Auditor Behaviour in CodeLaw Contexts: An Application to Failing Spanish Firms. European Accounting Review, 17(4), pp.


Allee, K. D., and T. L. Yohn, 2009. The demand for financial statements in an unregulated environment: An examination of the production and use of financial statements by privately held small businesses. The Accounting Review, 84(1), pp. 1–25.

Arruñada, B., 1999. The Provision of Non-Audit Services by Auditors: Let the Market Evolve and Decide. International Review of Law and Economics, 19(4), pp. 513-31.

Arruñada, B., 2011. Mandatory accounting disclosure by small private companies. European Journal of Law and Economics, 32, pp. 377–413 Australia Bureau of Statistics, 2001. Small Business in Australia, 2001. Available at http://www.abs.gov.au/AUSSTATS/abs@.nsf/mf/1321.0, visited 20. November 2012.

Ball, R. and L. Shivakumar, 2005. Earnings quality in UK private firms: comparative loss recognition timeliness. Journal of Accounting and Economics, 39(1), pp. 83-128.

Ball, R. and L. Shivakumar, 2006. The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition. Journal of Accounting Research, 44(2), pp. 207-242.

Bauwhede, H.V. and M. Willekens, 2004. Evidence on, the Lack of) Audit-quality Differentiation in the Private Client Segment of the Belgian Audit Market. European Accounting Review, 13(3), pp.


Beck, P.J. and M.G.H. Wu, 2006. Learning by Doing and Audit Quality. Contemporary Accounting Research, 23(1), pp. 1-30.

Berry, A. and J.Robertson, 2006. Overseas bankers in the UK and their use of information for making lending decisions: Changes from 1985. The British Accounting Review 38: 175-191.

Blackwell, D., T. Noland, and D. Winters, 1998. The Value of Auditor Assurance: Evidence from Loan Pricing. Journal of Accounting Research. 36: 57–70.

Burgstahler, D.C., L. Hail, and C. Leuz, 2006. The importance of reporting incentives: Earnings management in European private and public firms. The Accounting Review, 81(5), pp. 983Cano-Rodriguez, M., 2010. Big Auditors, Private Firms and Accounting Conservatism: Spanish Evidence. European Accounting Review, 19(1), pp. 131–159.

Cano Rodriguez, M., and S.S. Alegria, 2012. The value of audit quality in public and private companies:

evidence from Spain. Journal of Management & Governance, 16(4), pp. 683-706 Carey, P., R. Simnett, and G. Tanewski, 2000. Voluntary Demand for Internal and External Auditing by Family Businesses. Auditing: A Journal of Practice and Theory 19, Supplement, pp. 37-51.

Carello, J.V, A. Vanstraelen, and M. Willenborg, 2009. Rules Rather than Discretion in Audit Standards:

Going-Concern Opinions in Belgium. The Accounting Review, 84(5), pp. 1395-1428.

Cassar, G., 2011. Discussion of The Value of Financial Statement Verification in Debt Financing:

Evidence from Private U.S. Firms. Journal of Accounting Research, 49(2), pp. 507-528

Causholli, M., M. De martinis, D. Hay, and W.R. Knechel, 2010. Audit Markets, Fees and Production:

Towards An Integrated View of Empirical Audit Research. Journal of Accounting Literature, 29, pp. 167-215.

Chaney P., D. Jeter, and L Shivakumar, 2004. Self-Selection of Auditors and Audit Pricing in Private Firms. The Accounting Review, 79(1), pp. 51-72.

Choi, J.H., C. Kim, J.-B. Kim, and Y. Zang, (2010). Audit Office Size, Audit Quality, and Audit Pricing.

Auditing: A Journal of Practice & Theory, 29(1), pp. 73-97.

Clatworthy, M.A., G.H. Makepeace, and M.J. Peel, (2009). Selection bias and the Big Four premium:

new evidence using Heckman and matching models. Accounting and Business Research, 39(2) pp. 139-166.

Collis, J., R. Jarvis, R. and L. Skerratt, 2004. The demand for the audit in small companies in the UK, Accounting and Business Research, 34(2), pp.87–100.

Collis, J., 2010. Audit Exemption and the Demand for Voluntary Audit: A Comparative Study of the UK and Denmark. International Journal of Auditing, 14, pp. 211–231 Coram, P., J. Ng, and D. R. Woodliff, 2004. The effect of risk of misstatement on the propensity to commit reduced audit quality acts under time budget pressure. Auditing: A Journal of Practice & Theory, 23(2), pp. 159–167.

DeAngelo, L., 1981. Auditor Size and Audit Quality. Journal of Accounting and Economics, 3, pp. 183De Franco, G., I. Gavious, J.Y. Jin, and G.D. Richardson, 2011. Do Private Company Targets that Hire Big 4 Auditors Receive Higher Proceeds? Contemporary Accounting Research, 28(1), pp. 215Dyer Jr., W. Gibb., 2006. Examining the "Family Effect" on Firm Performance. Family Business Review, 19(4), pp. 253-273.

ESCP Europe, 2011. Study on the effects of the implementation of the acquis on statutory audits of annual and consolidated accounts including the consequences on the audit market. Final Report, November 9th.

European Commission, 1978. Fourth Council Directive 78/660/EEC of 25 July 1978 based on Article 54(3)(g) of the Treaty on the annual accounts of certain types of companies.

European Commission, 2006. DIRECTIVE 2006/46/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 14 June 2006 amending Council Directives 78/660/EEC on the annual accounts of certain types of companies, 83/349/EEC on consolidated accounts, 86/635/EEC on the annual accounts and consolidated accounts of banks and other financial institutions and 91/674/EEC on the annual accounts and consolidated accounts of insurance undertakings.

European Commission, 2006. DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Council Directive 78/660/EEC on the annual accounts of certain types of companies as regards micro-entities.

European Commission, 2010. GREEN PAPER. Audit Policy: Lessons from the Crisis.

Fortin, S. and J.A. Pittman, 2007. The Role of Auditor Choice in Debt Pricing in Private Firms.

Contemporary Accounting Research, 24(3), pp. 859-96 Francis, J.R., 2011. A Framework for Understanding and Researching Audit Quality. Auditing: A Journal of Practice & Theory, 30(2), pp. 125–152 Francis, J.R., I.K. Khurana, X. Martin, and R. Pereira, 2011. The Relative Importance of Firm Incentives versus Country Factors in the Demand for Assurance Services by Private Entities.

Contemporary Accounting Research, 28(2), pp. 487–516.

Gaeremynck, A, S Van Der Meulen, and M. Willekens, 2008. Audit portfolio characteristics and client financial reporting quality, European Accounting Review, 17 (2) pp. 243-270.

Goodwin, J., 2011. Audit Partner Busyness and Audit Quality. Working paper, The Hong Kong Polytechnic University.

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