The Demand for Private Company Audits: Evidence from Private Commercial Banks

Abstract

I investigate the demand for and benefits of private company audits. Agency theory predicts audits are demanded as a monitoring mechanism. I consider two sources of this demand - external stakeholders and management - and related benefits. First, audits may be used to reduce agency costs associated with the existence of external stakeholders. Second, management may use an audit to obtain the auditors' industry and financial expertise to reduce greater agency costs associated with more complex operations and as a consequence, add value to the bank. I consider audit decisions by small, privately-held commercial banks where there is no regulatory requirement for an audit. While the demand related to external monitoring is mixed, I consistently find that banks with more complex operations are more likely to have an audit consistent with expertise-driven demand. Consistent with these demands, audited banks experience higher yields and efficiency, but do not enjoy lower costs of capital.

Keywords: Audit, bank, governance, agency cost

JEL Classification: G21, M41, M49, G12, G34