Audits of Public Companies
33 Pages Posted: 13 Jul 2004
Date Written: June 29, 2004
Abstract
This paper develops a theory that explains why the government, on behalf of the public it serves, demands audits of public companies. Our theory argues that the government demands audits as a way to minimize private and public transaction costs defined as "the cost of measuring the valuable attributes of what is being exchanged and the costs of protecting rights and policing and enforcing agreements" (Dahlman 1979). The reduction of both types of transaction costs is a logical purpose of government as it maximizes the overall wealth of its citizens. The two different types of transaction costs, in turn, lead to two types of audits: private stewardship audits and public transparency audits. While stewardship audits employ contractual standards and fiduciary obligations to resolve agency problems, public audits employ generally promulgated standards for recognition, measurement and public disclosures that facilitate contracting among many constituents. Public audits also generally require auditor independence to objectively resolve broader economic, measurement, and communication issues. Our paper extends the theories of Jensen and Meckling (1976) and Watts and Zimmerman (1983, 1986) to incorporate public transaction costs and the effects of public disclosure and standards on independence. Our theory suggests a public policy emphasis on reducing transaction costs through independence, objective standards, and public accountability.
Keywords: Stewardship audits, transparency audits, transaction costs
JEL Classification: L50, M41, M49, G34, G38
Suggested Citation: Suggested Citation