Mandatory Audits of Private Companies

Abstract

We examine mandatory audits using Spanish private companies to generate insight into (1) how audit thresholds vary in tightness and impact, (2) which audit thresholds are crossed to cause audit commencement and cessation, (3) whether firms take actions to avoid audits and (4) whether audits provide economic benefits. Sample firms are subject to mandatory audits when they exceed two of three size thresholds for assets, revenue and number of employees. Investigating these thresholds, we find significant variation in their impacts on mandatory audits: The assets threshold is the tightest, whereas the number of employees is the least tight, and revenue best distinguishes mandatory audit status. Using discontinuity analysis, we find evidence that firms take actions to avoid crossing the audit thresholds, especially if another threshold has already been exceeded. Finally, we find that mandatory audits are associated with decreased borrowing costs and increased levels of debt that may persist beyond audit cessation. Our study provides regulators with insights into how each size threshold drives mandatory audit status. We also demonstrate that despite providing economic benefits, firms act to avoid mandatory audits, which suggests that regulators should seek to reduce the frictions driving such behaviour.