The Demand for External Auditing: Size, Debt and Ownership Influences Author(s): Chee W. Chow Source: The Accounting Review, Vol. 57, No. 2 (Apr., 1982), pp. 272-291 Published by: American Accounting Association Stable URL: http://www.jstor.org/stable/247014 . Accessed: 20/09/2014 05:49
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THE ACCOUNTING REVIEW Vol. LVII, No. 2 April 1982
The Demand for External Auditing:
Size, Debt and Ownership Influences
Chee W. Chow
ABSTRACT: This study uses an agency theory framework to analyze firms' incentives to hire external auditing. It postulates that a major reason for firms to hire this service is to help control the conflict of interests among firm managers, shareholders, and bond- holders. Firm characteristics which affect the severity of this conflict or the marginal cost of external auditing are expected to influence a firm's demand for this service. Based on this analysis, leverage, firm size, and number of accounting-based debt covenants are predicted to increase the probability that a firm will voluntarily hire external auditing. The firm manager's ownership share is predicted to have the opposite effect. Univariate and multivariate tests were conducted on a sample of 165 NYSE and OTC firms from the year 1926. The results generally supported the hypothesized effects of leverage and accounting-based debt covenants, and moderately supported the predicted role of firm size. Manager ownership effects could not be tested due to data problems.
I. INTRODUCTION IN recent years, large-scale auditing
scandals like Continental Vending and National Student Marketing
have focused public attention on audi- tors' incentives and ability to uphold professional standards in audits. Critics claim that firm managers control the selection of external auditors and can thus obtain auditor certification of finan- cial statements which conform with their preferences.' This belief is apparently shared by accounting standard-setting bodies. The Securities and Exchange Commission (SEC) has steadily increased its disclosure requirements for auditor- client relationships.2 Even the U.S. Con- gress has expressed its concern in the Moss Committee Report  and the Metcalf Committee Staff Report ; the...