Why Do Private Companies Demand Auditing? A Case for Organizational Loss of Control

Abstract

The objective of this paper is to explain the motivation for owners of private companies to voluntarily demand audit (positive) assurance. It is hypothesized that the owner/manager seeks audits as compensatory control systems for the organizational loss of control inherent in hierarchical organizations. Thus, the expected value of wealth at risk due to loss of control sets a lower limit on the amount owners would be willing to pay for audits to compensate for that loss. The hypothesized relationship was tested using information for 103 private companies demanding audit (positive) assurance. The obtained relationships were basically unaltered by the introduction of lenders' requirement of audits (n = 40). Furthermore, the hypothesized compensatory aspect of audit assurance was absent for the demand for negative assurance (reviews) in a sample of 31 companies. This is consistent with the fact that negative assurance is not viewed as a way of providing confidence so as to compensate owners for loss of direct supervision and control.