Int. J. Critical Accounting, Vol. 5, No. 3, 2013 The insignificance of auditor selection in the valuation of private companies within the public acquisition market James A. DiGabriele Department of Accounting, Law and Taxation, School of Business, Montclair State University, One Normal Avenue, Montclair, NJ 07042, USA Fax: (973)-243-2646 E-mail: digabrielej@mail.montclair.edu E-mail: jim@dmcpa.com Abstract: Previous research has set a firm position on quality and credibility of accounting information in the audit markets. Firth and Smith (1992), Firth and Liau-Tan (1998) and DeFranco et al. (2010) observed that brand name auditors provide higher assurance and credibility to the audited financial statements of companies with little or no trading history. However, in light of this reputable research, the established view from major professional accounting groups is that audits are the same regardless of the audit firm implying auditing homogeneity (Niskanen et al., 2010). The results from this analysis indicated that the price of a privately held company did not vary as a function of the audit firm performing the audit. Two analyses were performed comparing private companies audited by the largest ten accounting firms vs. all others, and Big 5(4) firms opposed to the remaining. Keywords: auditor selection; private companies; acquisition; accounting firm; audit quality; valuation. Reference to this paper should be made as follows: DiGabriele, J.A. (2013) ‘The insignificance of auditor selection in the valuation of private companies within the public acquisition market’, Int. J. Critical Accounting, Vol. 5, No. 3, pp.275–287. Biographical notes: James A. DiGabriele is an Associate Accounting Professor at Montclair State University. His primary research focuses on forensic accounting, private company valuation, investigative accounting and auditing. His principle teaching areas are forensic accounting, fraud examination, auditing and the fundamentals of financial accounting at the graduate level. He is frequently called upon as an expert witness in accounting litigation proceedings within the USA. Copyright © 2013 Inderscience Enterprises Ltd. 275 276 1 J.A. DiGabriele Introduction Private company targets entering the merger and acquisition market face the hurdle being characterised as less visible, less transparent and difficult to value by potential acquirer’s in the investment community. The primary difference between a private and public target is the quantity, quality and, availability of information (Capron and Shen, 2007). In its simplest terms, public targets have statutory audit requirements whereas private firms have more discretion over the information they desire to disclose (Reurer and Ragozzino, 2007). Hence, private sellers attempt to make every effort to achieve parity within the acquisition market in order to maximise sales price. One method to bridge the information gap between a private and public seller would be to engage a larger audit firm to provide the perceived level of assurance, quality and credibility an acquirer requests. Previous research has set a firm position on quality and credibility of accounting information in the audit markets. Firth and Smith (1992) observed that brand name auditors provide higher assurance and credibility to the audited financial statements of companies with little or no trading history. Private companies squarely fit that profile. Carpenter and Strawser (1971) reported the results of an AICPA survey concerning auditor change and found that underwriters routinely advised clients to retain a nationally known audit firm in order for their initial public offering (IPO) to sell at the highest price. These findings are consistent with prior streams of research on audit quality and credibility. For example, DeAngelo (1981) maintained that large audit firms have more wealth at risk than smaller firms therefore, have a greater incentive to issue higher quality audit reports. Additional researchers have found the stock market to react more positively when a company changes auditors from a small firm to a large audit firm (Nichols and Smith, 1983; Eichenseher et al., 1989). Since pricing is an issue for private firms, acquirers would also seek the ability to forecast future earnings and accordingly estimate firm value. Lee et al. (2007) found audits performed by larger accounting firms provided investors with the capability to recognise future earnings and make better estimates of value. However, in light of this reputable research, the established view from major professional accounting groups is that audits are the same regardless of the audit firm implying auditing homogeneity (Niskanen et al., 2010). Boone et al. (2009) found evidence of similar audit quality between Big 4 and mid-tier auditors. This research suggests investors also consider Big 4 and mid-tier auditors to offer audit opinions of comparable quality (Boone et al. 2009). The previous notion that a private company entering the public markets must use a Big 4 auditor appears to be weakening (Tyranski, 2008). Recent statistics also signify that national and regional audit firms are increasing their market share of public company audits (Tyranski, 2008). This suggests the perception and credibility of non-Big 4 audit firms is gaining in status. The increase in standing of non-Big 4 firms persuasively motivates this research to further investigate whether auditor choice in private company acquisitions engender valuation differences in the public markets. This manuscript makes several contributions to the academic research on auditing and the valuation of private companies. First, this research directly contributes an incremental layer of knowledge to the literature by testing the idea of whether a brand name auditor adds value to a private company target’s selling price in the public acquisition market. This is essential knowledge to the entire academic and practitioner audit community The insignificance of auditor selection in the valuation of private companies 277 because this refines the quality/credibility perceptions of auditors. Second, this research offers actual transaction evidence of valuation differentials for private company targets based upon auditor choice. This information is important to participants of the investment community that include investment bankers, underwriters, and valuation analysts. Third, this research is highly coveted by private company sellers since, their view and reality of using a large audit firm could in fact differ. Finally, this research fills a gap due to a dearth of research available in the private company and auditor choice area. This paper is organised as follows; the next section reviews the literature that motivates the study. Section 3 describes the research design. Section 4 explains the data and sample period. Section 5 addresses the results with Section 6 discussing the findings of the study, and the final section concludes the paper. 2 Motivation for study It has been established that larger audit firms have more resources than smaller firms and debatably provide better quality audits (Louis, 2005). Conversely, smaller audit firms perhaps possess a number of comparative advantages (Louis, 2005). Smaller firms’ personnel are likely to hold an advantage over larger accounting firms in knowledge of the local markets where private companies operate. This familiarity has the potential to add value in an acquisition transaction through easing the cost of information asymmetry (Tyranski, 2008). Smaller accounting firms in conjunction with communal relationships and equitable reputations within their operating business communities are able to leverage this insight for the benefit of a private company target (Louis, 2005). Utilising this inimitable understanding of the private company financial reporting system, transactional flow, and prospective control breaches place smaller accounting firms in a unique position by providing the suitable financial information to estimate the highest selling price (Niskanen et al., 2010; Boone et al., 2009). Addams and Davis (1994) surveyed CEOs of privately held companies. The authors found privately held companies principally valued the personal relationships with their smaller firm auditors, the trusted advice received, responsiveness and overall understanding of their business. Privately held company CEOs believe this familiarity and grasp furnishes smaller accounting firms with the ability to develop remedial actions to ensure the complete and accurate reporting of information for both management and external reporting requirements (Addams and Davis, 1994; Louis, 2005). Investors have viewed the small audit firm-client advisory relationship positively as long as the role is independent with continued confidence in the financial statements (SEC, 2004). Lee et al. (2007) found further evidence of smaller accounting firms advancing in prominence as the relationship between auditor size, company size and the ability to predict future earnings was not significant as their sample approached the new millennium. The authors’ offer additional support for the importance of reliable financial statement information, and its affect on company price. Berton (1994) observed smaller clients analogous to privately held companies were unhappy with the lack of service, level of personnel assigned, and neglect they receive from larger auditing firms. Smaller audit clients are usually assigned many different personnel when using larger accounting firms that are often inexperienced auditors (Louis, 2005). Larger accounting firms are inclined to engage in this practice to focus 278 J.A. DiGabriele efforts on “more lucrative business with larger clients” (Louis, 2005). Accordingly, smaller audit clients in acquisition mode have come to perceive this behaviour from larger audit firms as potentially costing their companies a maximised sale price by missing specific reporting opportunities (Tyranski, 2008). The perceived benefits associated with a brand name audit opinion conceivably do not exceed the cost of inexperience auditors assigned to the audit by larger accounting firms. In small firm counterparts, their advantage is in having savvy higher level auditors (partners) with requisite knowledge actually performing the audit (Addams and Davis, 1994; Louis, 2005). This practice suggests management of private companies seeking to maximise value perceive this as a risk of information asymmetry (Niskanen et al., 2010; Boone et al., 2009). Investors perhaps also embrace the same view. Statistics continue to indicate that smaller accounting firms are consistently alluring market share of audit services from larger firms (Tyranski 2008, Louis 2005). In summary, this research proposes that the price of a private company entering the public acquisition market will be unaffected by auditor choice. Although prior research (Firth and Smith, 1992; Firth and Liau-Tan, 1998; DeFranco et al., 2010) has found that the prices of privately held companies entering the public markets were higher due to the perceived value of using a brand name auditor. This paper posits that these difference have been neutralised by the exceptional knowledge of local markets offered by smaller firms (Louis, 2005), the “trusted business advisor relationship in a non-management” function smaller CPA firms have been know for (SEC, 2004), and better client service provided by smaller accounting firms (Tyranski, 2008). The implications of this research rationalise between the auditing markets served by firms based on perceptions of the participants and private company value. 3 Research design The models used to test for valuation variation among audit firms are based upon empirical models of DiGabriele (2008), Erickson and Wang (2007) and Mattson et al. (2002a, 2002b). A moderated multiple regression model was developed. The model employs parsimonious variables that confines and controls for multidimensional factors that affect valuation. The form is set in two stages as follows; 1 Y (lnPurchase Price) = α + β1 (lnNet Sales) + β2 (Auditor Type) 2 Y (lnPurchase Price) = α + β1 (lnNet Sales) + β2 (Auditor Type) + β3 (Auditor Type × Sales) where • lnPurchase Price = natural logarithm of selling price • lnNet Sales = centred natural logarithm of firms’ sales • Auditor Type = 1 large audit firm and 0 if small audit firm • Sales × Auditor = product variable of lnNet Sales multiplied by Auditor Type. The insignificance of auditor selection in the valuation of private companies 279 Private companies are often structured in an organisational form such as, an S Corporation, Limited Liability Company or Partnership, (FTEs) that minimises overall income taxes (Schwidetzky, 2009). These types of entities have varying compensation arrangements that differ from regular corporations due their advantageous single layer of taxation (Schwidetzky, 2009). Kamstra (2003) suggests when comparing entities with different compensation designs net sales provide a strong relationship to price because net income-based metrics such as earnings before income taxes, depreciation and amortisation (EBITDA) are likely to vary across organisational form and accordingly will not provide useful comparisons. Additionally, lnNet Sales serve a multidimensional purpose in this economical model. Damodaran (2002) and Kamstra (2003) have indicated that net sales are a sufficient proxy of company size for private companies, as public buyer’s associate revenue with market share in the acquisition markets. lnNet Sales are expected to have a positive relationship to price. Firth and Liau-Tan (1998) suggested the selling prices of privately held companies entering the public marketplace that utilised a larger auditor were higher than their private company counterparts that did not use a large audit firm. Louis (2005) found a contrary position in that smaller accounting firms have a ‘comparative advantage’ over larger auditing firms in the merger markets. Both studies operarationalised the type of audit firm using an indicator (dummy) variable. This variable reasonably captures the theoretical constructs delineated in this study and associated with each type of firm. Consistent with prior research this study uses a dummy variable to measure if Auditor Type affects valuation. It is expected that there is no difference between large and small audit firms. Previous research has not considered the possibility of a variable moderating the relationship between auditor type and firm pricing. The second stage included interaction variables between lnNet Sales by Auditor Type. Aiken and West (1991), Jaccard and Turrisi (2003) and Aguinis (2004) recommended a two stage technique to appropriately examine whether a moderating effect exists. Evidence of this effect would be demonstrated by a corresponding increase to the model R squared in the second stage. The addition of a two-way interaction term in the model is based on the possibility that the change in the dependent variable as one of the independent variables changes, depends on the value of another independent variable (Jaccard and Turrisi, 2003). Prior research has found higher sales have the potential to obtain larger valuation premiums and big audit firms typically audit larger clients than their smaller counterparts (Mattson et al., 2002a, 2002b; Erikson and Wang, 2007; Boone et al., 2009; Niskanen et al., 2010). Correspondingly, the product variable lnNet Sales by Auditor type was included among the independent variables. It is expected the moderating term offers no significant explanatory power to the model. 4 Sample selection The sample was obtained from the online database of mergers and acquisitions, SDC Platinum. This study covered acquisitions completed between January 1999 through December 2009. The transactions included in the sample satisfied the following criteria: 280 J.A. DiGabriele 1 the target auditor was identified 2 net sales were reported 3 the selling price reported 4 standard industry classification codes (SIC) was included 5 public acquirer. Tests of comparisons for acquisitions were preformed consistent with prior empirical research of Erickson and Wang (2007) and Mattson et al. (2002a, 2002b), an industry matched sample was utilised. This type of matching methodology produces controlling benefits for industry, company size and acquisition type (stock/asset) while providing a meaningful valuation relationship (Erickson and Wang, 2007; Mattson et al., 2002a, 2002b). There are 74 matched pairs of merger and acquisition transactions of private companies that have met the selection criteria for the sample. 5 Results 5.1 Descriptive analyses The 74 matched pairs were analysed by segregating the top ten accounting firms according to Accounting Today Top 100 Firms (AT) (2010) from the non-top ten accounting firms. This approach is motivated by the findings of Boone et al. (2009). Their results indicate that investors view the audit quality provided by mid-tier auditors to be of similar quality as their Big 4 counterparts. The firms included in the study of Boone et al. (2009) is analogous to the top ten in AT’s rankings. In the descriptive analysis, the audit firms were set apart as non-top ten and top ten based upon AT’s 2010 rankings. There is virtually no difference between AT’s 2009 and 2010 rankings. Table 1 shows the frequency of audit by each of the auditing firms included in the sample. The auditing firms that had performed the highest number of audits in the current study were Pricewaterhouse Coopers (n = 15, 10.1%), Ernst and Young (n = 13, 8.8%), KPMG (n = 12, 8.1%), BDO Seidman (n = 9, 6.1%), Deloitte and Touche (n = 8, 5.4%), and Grant Thornton (n = 8, 5.4%). Descriptive statistics are provided for price and sales data in Table 2. Values for price and sales are in millions of US$. Price values ranged from .28 to 750.00 with a mean of 55.86 (SD = 88.77). For sales, values ranged from .09 to 543.00 with a mean of 40.26 (SD = 83.85). The skewness and kurtosis values for both sales and price in dollars indicated substantial non-normality. Therefore, the natural logs of these variables were computed. As can be seen in Table 3, the natural log transformations were approximately normal (with skewness and kurtosis values less than 1.00 in all cases). The natural logs were used in all subsequent analyses. The difference in natural log of price as a function of top ten firm or not, was not statistically significant, t(146) = –.75, p = .453. The natural log of price and the natural log of sales were positively correlated, r = .60, p < .001. The means, standard deviation and frequencies are illustrated in Table 3. The insignificance of auditor selection in the valuation of private companies Table 1 281 Sample frequency and percentage of auditing firms (N = 148) Firm Frequency Percentage Pricewaterhouse Coopers Ernst and Young KPMG BDO Seidman Deloitte and Touche Grant Thornton Arthur Andersen and Co. UHY Armanino McKenna Bonadio and Co. McGladrey and Pullen Amper Politziner and Mattia Crowe Chizek and Co. Hein and Associates Jewett Schwartz and Associates JH Cohn Mauldin and Jenkins Schumacher and Associates Smaller Firms Performing 1 Audit 15 13 12 9 8 8 5 4 3 3 3 2 2 2 2 2 2 2 51 10.1% 8.8% 8.1% 6.1% 5.4% 5.4% 3.4% 2.7% 2.0% 2.0% 2.0% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 34.5% Total 148 100.0% Note: A sample of firms included in the 51 are, Wiss and Co., Dixon Hughes, and Eisner. Table 2 Descriptive statistics for price and sales (N = 148) Variable Min. Max. M SD Skewness Kurtosis Price Sales Natural log of price Natural log of sales .28 .09 –1.27 –2.42 750.00 543.00 6.62 6.30 55.86 40.26 3.22 2.48 88.77 83.85 1.31 1.60 4.29 3.86 –.11 –.14 26.47 16.57 .11 .62 Note: Price and sales data are in millions of dollars. Table 3 Big 10 and non-Big 10 frequency, mean and standard deviation Panel A: Use of auditing firms (N = 148) Firm Non-Big 10 Big 10 Frequency Percentage 74 74 50 50 Panel B: Natural log of price as a function of accounting firm group (N = 148) Firm Non-Big 10 (n = 74) Big 10 (n = 74) M SD 3.14 3.31 1.38 1.24 Note: The difference in natural log of price as a function of top ten firm or not was not statistically significant, t(146) = –.75, p = .453. 282 J.A. DiGabriele A second analysis is also included in this study and descriptive statistics are also provided. Consistent with prior research of Beatty (1989), Firth and Smith (1992), Firth and Liau-Tan (1998), Fortin and Pitman (2007) and DeFranco et al. (2010), the data were further partitioned to replace the dummy variable in the first analysis (non-top ten firm/top ten firm) to non-Big 5(4) or Big 5(4) to determine if valuation differences existed with the use of a Big 5(4) auditor. Since the sample period covered years that included Arthur Andersen, Big 5(4) will be used interchangeably. The use of Big 5(4) auditing firms is summarised in Table 4. A total of 53 of the transactions examined in this study involved an audit by a Big 5(4) firm (35.8%), 95 transactions (64.2%) involved non-Big 5(4) firms. The means, standard deviation and frequencies are illustrated in Table 4. The difference in natural log of price as a function of top five firm or not was not statistically significant, t(146) = –.63, p = .530. Table 4 Big 5 and non-Big 5 frequency, mean and standard deviation Panel A: Use of auditing firms (N = 148) Firm Frequency Percentage Non-Big 5 95 64.2 Big 5 53 35.8 Panel B: Natural log of price as a function of accounting firm group (N = 148) Firm M SD Non-Big 5 (n = 95) 3.13 1.38 Big 5 (n = 53) 3.31 1.24 Note: The difference in natural log of price as a function of top five firm or not was not statistically significant, t(146) = –.63, p = .530. 5.2 Inferential analyses Preliminary examination of the bivariate relationships between the dependent variable, the natural log of price, the two independent variables, the natural log of sales and whether or not the firm was a Big 5(4) or Big 10 firm was performed. The natural log of price and the natural log of sales were positively correlated, r = .60, p < .001. Tables 2 and 4 display the natural log of price values as a function of whether or not the transaction involved an audit by a Big 5 firm or not, or an audit by a Big 10 firm or not. The comparison of the average natural log of price between Big 5(4) firms and other firms was not statistically significant, t(146) = –.63, p = .530. This indicated that the average natural log of price for audits by Big 5 firms (M = 3.17, SD = 1.38) was not significantly different from the average natural log of price for audits by other firms (M = 3.32, SD = 1.18). The comparison between Big 10 firms and other firms was also not statistically significant, t(146) = -.75, p = .453), indicating that the average natural log of price for audits by Big 10 firms (M = 3.14, SD = 1.38) was not significantly different from the average natural log of price for audits by other firms (M = 3.31, SD = 1.24). Table 5 exhibits the results of the regression analysis with Big 10 or not auditor type as a predictor variable. In the first block of the model, 36% of the variance in the natural log of price was explained (R2 = .36, adjusted R2 = .35), which was statistically significant, F(2, 145) = 40.82, p < .001. The natural log of sales was statistically significant, β = .61, p < .001, but whether or not the audit was conducted by a Big 10 firm The insignificance of auditor selection in the valuation of private companies 283 or not was not, β = –.06, p = .366. The addition of the interaction term in the second block increased the variance explained to 37% (change R2 = .01), but the additional variance explained was not statistically significant, [change F(1, 144) = 1.91, p = .169], and the interaction term was not statistically significant, β = –.13, p = .169. Therefore, based on the results of this analysis it can be concluded that a the natural log of sales was positively related to the natural log of price b whether or not the audit was conducted by a Big 10 firm was not related to the natural log of price c the positive relationship between the sales and price was not affected by whether or not the audit was conducted by a Big 10 firm. Table 5 Results of moderated multiple regression analysis with natural log of sales, top ten firm or not, and their interaction as predictors of the natural log of price (N = 148) B SEB Constant 3.30 .12 26.68 .000 Natural log of sales .50 .06 .61 8.99 .000 Big 10 firm –.16 .18 –.06 –.91 .366 Constant 3.33 .12 Natural log of sales .57 .08 β t p Block 1 Block 2 .70 26.68 .000 7.36 .000 Big 10 firm –.16 .18 –.06 –.91 .365 Interaction –.15 .11 –.13 –1.38 .169 Notes: Block 1 R2 = .36, adjusted R2 = .35, F(2, 145) = 40.82, p < .001. Block 2 R2 = .37 adjusted R2 = .36, F(3, 144) = 28.02, p < .001, change R2 = .01, change F(1, 144) = 1.91, p = .169. A second analysis was performed substituting a Big 5(4) audit firm in place of the Big 10 firm and the interaction between them as independent variables. These results are shown in Table 6. The first block of the model contained the natural log of sales and Big 5(4) firm as predictors. This model explained 36% of the variance in the natural log of price (R2 = .36, adjusted R2 = .35), and this was statistically significant, F(2, 145) = 40.18, p < .001. The natural log of sales was statistically significant in this model, β = .60, p < .001, but whether or not the audit was performed by a Big 5 firm was not (β = –.01, p = .924). When the interaction was added in the second block, the increase in variance explained was 0% (change R2 = .00), and this was not statistically significant, change F(1, 144) = .14, p = .706. The interaction term was not statistically significant, β = –.03, p = .706. The results from this analysis indicated that a the natural log of sales was positively related to the natural log of price b whether or not the audit was conducted by a Big 5 firm was not related to the natural log of price c the effect of sales on price did not vary as a function of whether or not the audit was conducted by a Big 5 firm. 284 J.A. DiGabriele Table 6 Results of moderated multiple regression analysis with natural log of sales, Big 5 firm or not, and their interaction as predictors of the natural log of price (N = 148) B SEB β t p Block 1 Constant 3.23 .11 29.73 < .001 Natural log of sales .49 .05 .60 8.93 < .001 Big 10 firm –.02 .18 –.01 –.10 .924 Block 2 Constant 3.23 .11 29.63 < .001 Natural log of sales .50 .07 .62 7.20 < .001 Big 10 firm –.01 .18 –.01 –.08 .939 –.04 .11 –.03 –.38 .706 Interaction 2 2 Notes: Block 1 R = .36, adjusted R = .35, F(2, 145) = 40.18, p < .001. Block 2 R2 = .36 adjusted R2 = .34, F(3, 144) = 26.68, p < .001, change R2 = .00, change F(1, 144) = .14, p = .706. 6 Discussion Several informal unstructured interviews ensued subsequent to the results. Four individuals were interviewed, 1 auditor with Big 5(4) and small firm experience 2 auditor with mid-tier firm and small firm experience 3 a private company CEO seeking to sell the company and an entrepreneur (CEO) in the food service industry with many years of experience purchasing companies. The main topic was centred on, how the results of this study differed from the expectations of the interviewees. The first participant (PN1) is a CPA with extensive Big 5(4) audit experience and small firm familiarity. The results did not differ from PN1’s perspective on the issue. PN1 denoted that smaller firms cannot accept the risk liability larger firms can. Hence, smaller firms are more skeptical assessing fraud risks because they have more experienced auditors at the ground level to remedy these types of issues. PN1 suggested large audit firms have too many junior accountants in integral positions that increase the likelihood of overlooking important reporting matters. The staffing issue is perpetuated by the business objective of standardising the process in larger firms. PN1 also believes that auditor perception resides more with the individual rather than the brand. However, PN1 acknowledged a sample of investment bankers that dissuade private companies from using smaller audit firms due to the ‘deep pockets’ of larger firms. Participant number two (PN2) is a former mid-tier firm auditor and a partner in a local CPA firm. The results of the study are consistent with PN2’s expectations. PN2 deems regardless of audit firm size the same standards are followed and there should not be a difference in the reliance or use of the financial statements. Moreover, with the The insignificance of auditor selection in the valuation of private companies 285 frauds of the early 2000s and subsequent subprime crisis, PN2 identifies these events directly contributing to the waning public confidence in Big 5(4) audit firms. This participant considers it is a valuation fallacy to suggest the sales price of a private company would receive a premium for simply having a large audit firm certify the financial statements. The third participant (PN3) is the CEO, sole shareholder of a private company (40 million in revenue) seeking to eventually sell the business. PN3 makes use of a Big 5(4) to audit the financial statements of the company. The sole reason for this is that PN3 believes that if a particular audit brand accompanies the financial statements it will result in a higher price than if a local CPA firm completed the audit. PN3 was surprised by the results of this study because they were contrary to the advice received from professionals in the merger and acquisition field. As PN3 ‘tested the waters’ on commencing the process of selling the business, the pervasive recommendation from investment bankers was to have the company financial statements audited by a Big 5(4) in order maximise the selling price. Participant number four (PN4) has purchased many companies over the past 20 to 25 years in the food service industry. In earlier acquisitions PN4 preferred the majority of companies purchased had their financial statements audited by the Big 4(5) and did bid less on companies not using larger accounting firms. However, over time PN4 sensed the market changing and this issue gradually becoming insignificant. PN4 observed local audit firms providing similar quality as the Big 4(5) and more familiar with the clients business. PN4 noticed more expanded disclosure notes from local firms. PN4 perceived the larger firms were not able to relate to the smaller private company client. PN4 noted target private company audits by the Big (4)5 were routinely staffed by less experienced staff with partners rarely seen on site and could have been a quality issue contributing to the scores of corporate collapses within the recent decade. PN4 was not surprised at the results of this study and in recent acquisitions does not consider a price premium based on the auditor of the financial statements. 7 Conclusions This study imparts evidence that auditor reputation and perceived audit quality in the acquisition of private companies does not increase the sale price of comparable private targets. The results offer that any difference that previously could have existed dissipated due to the exceptional knowledge of local markets offered by smaller firms (Louis, 2005), the “trusted business advisor relationship in a non-management” function smaller CPA firms have been know for (SEC, 2004), and better client service provided by smaller accounting firms (Tyranski, 2008). The consistencies of the results are observed in the bivarate difference of means tests that calibrate the findings. As private company databases continue to populate transactions future research using an updated sample would certainly add to the body of knowledge of this topic. In addition, the testing of differences of specific advisors such as investments bankers and other intermediaries could be integrated in future empirical models. A limitation in the study is when a target employs a local audit firm while the purchaser performs their own due diligence using a Big 4(5) firm or not. 286 J.A. 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Securities and Exchange Commission (SEC) (2004) 23rd Annual SEC Government Business Forum on Small Business Formation, Transcript, 20 September. Tyranski, G.W. (2008) ‘Concentration and competition in the auditing profession’, CPA Journal, Vol. 78, No. 10, pp.10–11. The paper: “The insignificance of auditor selection in the valuation of private companies within the public acquisition market” delves into the true value, if any, that can be associated with the name and reputation of an auditing firm in application to the sale of a privately held company. Over the course of the paper, the findings provide numerous support to prove the claims, that the perception that big 4(5) auditing firms can provide a more reliable audit, is not based in any fact but rather derived from public opinion. Though the paper dives into the inexperience of the auditors representing big 4(5) firms, a further argument could be made on the age gap often found with auditors on the client site performing the audit. The paper makes reference to, “large audit firms have too many junior accountants in integral positions that increase the likelihood of overlooking important reporting matters” (DiGabriele 284). This should be harped on further as it is a major advantage that smaller to mid tier firms have. The concern that smaller private companies may have, in regards to a partner presence through the duration of the audit, is an understandable one. Private companies with a smaller business practice would greater desire a smaller team of more experienced auditors with industry specific experience as opposed to a large team of first, second, and third year auditors without a strong leadership presence. Perhaps if large firms were able to devote resources to specifically focus on smaller private companies they would be able to back up the claims that their enormous influence could be beneficial in applying all of their support systems to these audits. However, as DiGabriele states, “larger accounting firms are inclined to engage in this practice (i.e. bigger clients) to focus efforts on ‘more lucrative business with larger clients’” (DiGabriele 278). This is a sufficient enough reason for big audit firms to not apply their resources to such a specific group of small companies. In addition to the inexperience of the staff and the disinterest in putting resources to use on a less lucrative client, private companies often can be in very specific niche industries. It is argued in the paper that there is no difference between Big 4(5) audits and mid-tier firm audits but there may be, in fact, benefits that come into play with the type of industry that is being audited. Since a private company in a specific market, akin to the construction industry or the real estate industry perhaps, may have detailed nuances that would be better suited for an auditing group that can devote time. In addition, these smaller groups may have specific knowledge on how the industry is different when on the smaller private level. These types of firms need a smaller to mid-tier audit practice that specializes in their type of industry audits. Smaller firms can specialize on their knowledge of a certain industry and can really hone in on the audits of that industry and how it differs from the public version of these firms Especially in areas such as the scope of the market to determine proper levels of materiality, in turn, issuing a more efficient and accurate audit opinion . As we mentioned above, these larger audit firms may not devote large assets and resources to a specific industry on the small to medium private level. They may, in order to cut costs, normalize their training for many unrelated industries together, with the only thing linking them being that they fall into the private category. This can cause a plethora of issues not allowing for dedicated understanding of a particular private industry. This is quite the opposite of how public firms are approached within a big 4(5) firm, where the level of experience a public company auditor can often be regimented to such a granular point, stemming from the high demand for public audit clients, that we can see many experts in specific subsections of a public industry. Conversely, a smaller audit firm may devote a multitude of their assets and resources to these specific private industry practices, especially when they are familiar with the local factors that play a causal role in the way private companies sales, and income are affected. This may allow for a better quality audit and potentially, when old perceptions are dismantled, lead to a higher valuation for a private company.
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