Demand of auditing
Is the demand for auditing a regulatory artifact or market driven?
Pre SEC era:
There is evidence that before legislation on auditing existed there were still forms of auditing. In the medieval times there were the guilds, later audits were conducted by directors or shareholders of a company. In the 19th century US companies voluntarily contracted for audits.
Current data on non-SEC companies
In 1977, 80% of corporate audit clients of PwC are non-SEC-registrants (Biegler 1977).
Privately owned US firms are not required to purchase audits, those that do pay significant lower interest and are therefore interested in an audit.
Why do companies want an audit?
Information hypothesis:
An auditor reduces the information asymmetry between insiders and outsiders of the firm. As managers will have to provide accurate information on the firm to pass the audit.
Insurance hypothesis:
Audits are assumed to generate firm value primarily from three components: 1 Assurance 2 Insurance and 3 Service value (Sirois and Simunic 2010). The auditee and auditor are jointly liable to third parties for losses attributable to defective financial statements. In practice, managers, investment bankers and underwriters have incentives to insure themselves this way because of their professional liability exposures.
Real life case: Baseball cards
Traded at high prices via eBay in 1998, for example one card auctioned off for 1.1 million dollars. The trades were done over a distance so buyers were unable to physically inspect a card. Sellers started sending their cards to certification agencies to get them graded. Buyers are willing to pay a premium for the knowledge their cards will be in near-mint condition as opposed to heavily worn cards.
Apparently even without regulation there still is demand for audits.
Pre SEC era:
There is evidence that before legislation on auditing existed there were still forms of auditing. In the medieval times there were the guilds, later audits were conducted by directors or shareholders of a company. In the 19th century US companies voluntarily contracted for audits.
Current data on non-SEC companies
In 1977, 80% of corporate audit clients of PwC are non-SEC-registrants (Biegler 1977).
Privately owned US firms are not required to purchase audits, those that do pay significant lower interest and are therefore interested in an audit.
Why do companies want an audit?
Information hypothesis:
An auditor reduces the information asymmetry between insiders and outsiders of the firm. As managers will have to provide accurate information on the firm to pass the audit.
Insurance hypothesis:
Audits are assumed to generate firm value primarily from three components: 1 Assurance 2 Insurance and 3 Service value (Sirois and Simunic 2010). The auditee and auditor are jointly liable to third parties for losses attributable to defective financial statements. In practice, managers, investment bankers and underwriters have incentives to insure themselves this way because of their professional liability exposures.
Real life case: Baseball cards
Traded at high prices via eBay in 1998, for example one card auctioned off for 1.1 million dollars. The trades were done over a distance so buyers were unable to physically inspect a card. Sellers started sending their cards to certification agencies to get them graded. Buyers are willing to pay a premium for the knowledge their cards will be in near-mint condition as opposed to heavily worn cards.
Apparently even without regulation there still is demand for audits.