What drives voluntary audit adoption in small German companies?

• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/ijau.12134

ORIGINAL ARTICLE

What drives voluntary audit adoption in small German

companies?

Andreas Weik

1

|Brigitte Eierle

1

|Hannu Ojala

2,3

1

University of Bamberg, Bamberg, Germany

2

Aalto University School of Economics,

Helsinki, Finland

3

University of Tampere, Tampere, Finland

Correspondence

Andreas Weik, University of Bamberg,

Feldkirchenstraße 21, Bamberg 96047,

Germany.

Email: andreas.weik@uni‐bamberg.de

The purpose of this study is to validate the drivers of voluntary audit in small compa-

nies identified in previous research and uncover additional determinants related to

agency conflicts with owners. For our research we use the German institutional set-

ting, documented in the literature as being very different from its Anglo‐Saxon equiv-

alent. Based on a random sample of 405 small companies responding to a postal

questionnaire survey, we find that the proportion of owners not involved in manage-

ment, the subsidiary status of a company, a company's legal form, and the importance

of financial statements' information to management activities all increase the likeli-

hood of voluntary audit. In contrast, firms that outsource accounting tasks to an

external expert are less likely to opt for voluntary audit, suggesting that an external

expert's involvement substitutes for an external audit. In addition, owing to the

absence of a statutory audit history for small companies in Germany, we find that vol-

untary audits are less common compared with findings from previous studies.

KEYWORDS

Agency theory, auditorchoice, external audit

1|INTRODUCTION

In this study based on small German companies, we examine factors

affecting the owner‐manager's decision to hire an auditor. This study

advances our understanding of voluntary auditing for small companies

in an economically important bank‐dominated code law country, Ger-

many, where voluntary audit drivers have not previously been exam-

ined. Because of its exceptionally high exemption thresholds,

Germany makes possible the broadest examination of voluntary

auditing choices in Europe. Indeed, because most governance research

has examined US firms, Carcello, Hermanson, and Ye (2011) call for

more focus on non‐US firms, particularly firms in Continental Europe.

Those papers that have examined non‐US firms have tended to study

other countries that follow Anglo‐Saxon traditions of governance (e.g.,

Australia, Canada, the UK).

The European Commission has recently adopted a “think small

first”approach, which attempts to reduce the administrative require-

ments for small companies. This approach assumes that small entities

carry a disproportionately high burden of administrative costs, cover-

ing, for instance, the preparation of full financial statements and

auditing. Despite the need for research data to support political posi-

tions concerning costs and benefits or underlying reasons behind small

firms' economic decisions, the evidence regarding private companies'

financial accounting and auditing decisions remains very limited.

Although 99% of all businesses are small and medium sized (Euro-

pean Union [EU], 2014), possibly because it is more complex to access

private companies' data, their voluntary audit drivers have been exam-

ined far less often than the factors for audit quality in the case of pub-

licly listed companies. This lack of research evidence may, therefore,

lead to inappropriate generalization as a result of findings from

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided

the original work is properly cited.

© 2018 The Authors International Journal of Auditing Published by John Wiley & Sons Ltd

Received: 28 February 2016 Revised: 24 January 2018 Accepted: 14 June 2018

DOI: 10.1111/ijau.12134

Int J Audit. 2018;22:503–521. wileyonlinelibrary.com/journal/ijau 503

previous research studies having been gathered primarily from data

based on publicly listed companies or Anglo‐Saxon accounting set-

tings. According to the synthesis of prior auditing research on private

companies, Langli and Svanström (2014) argue that:

The differences that exist between private and public

companies are so large and fundamental that without

careful consideration we cannot rely on findings for

public companies when we want to understand the role

of auditing in private companies.

Responding to this call for additional evidence on voluntary audit

drivers and accounting processes in private companies, we gathered

survey questionnaire data from 405 usable responses by small private

companies in Germany regarding financial statements' information for

the financial year ending 2011. The data centered around questions

examining voluntary audit drivers that relate to: (i) agency conflicts

with owners; (ii) agency conflicts with lenders; (iii) the importance of

financial statements for management activities; and (iv) the

outsourcing of accounting tasks.

Our data show that voluntary audits are considerably less com-

mon among German firms than they are with firms in other countries.

While previous studies have found voluntary audit ranging between

26% and 80% (see Table 5) of businesses, we find that only 12% of

our sample companies opt for a voluntary audit. Our results indicate

that managers from countries where they have been subject to man-

datory audit regimes value the cost and benefits resulting from a vol-

untary audit very differently from those who have not, demonstrating

that the voluntary audit decision is likely to be influenced by previous

habits (Niemi, Kinnunen, Ojala, & Troberg, 2012; Oliver, 1991).

Regarding the drivers of voluntary audit, in line with previous

research, we find that the proportion of company owners who are

not involved in management (e.g., Collis, 2010, 2012; Seow, 2001;

Tauringana & Clarke, 2000) and the importance that managers place

on accounting information for management accounting purposes

(Collis, 2010, 2012; Collis, Jarvis, & Skerratt, 2004; Niemi et al.,

2012) increase the likelihood of an auditor being hired voluntarily. In

contrast with previous studies on voluntary audit, we cannot find sup-

port for the status as a family firm (e.g., Collis, 2010; Collis et al.,

2004), ownership dispersion (Dedman, Kausar, & Lennox, 2014), or

leverage (Carey, Simnett, & Tanewski, 2000; Dedman et al., 2014;

Tauringana & Clarke, 2000) impacting on a firm's voluntary audit deci-

sion. However, extending previous research, we do find evidence that

the legal form in which a company operates, the status as a subsidiary,

and outsourcing are further factors impacting on a manager's volun-

tary audit decision. By further examining the professional qualifica-

tions of those to whom accounting tasks are outsourced, we provide

evidence that outsourcing accounting tasks to an external tax advisor

decreases the likelihood of a voluntary audit, whereas outsourcing

accounting tasks to an external auditor increases the likelihood of a

voluntary audit. Subject to the professional qualifications of those to

whom financial accounting tasks are outsourced, this result suggests

that auditing can play a substitutive or a complementary role.

Our study contributes to the literature as follows. First, it vali-

dates earlier research findings from other jurisdictions in an institu-

tional setting that has been documented in the literature as being

very different from the Anglo‐Saxon regime (Alexander, Britton,

Jorissen, Hoogendoorn, & van Mourik, 2014) and which lacks a statu-

tory audit history for small companies. Second, our study takes a more

profound approach than earlier studies (e.g., Niemi et al., 2012) in

examining the link between the voluntary audit decision and

outsourcing accounting tasks. Considering the different professional

qualifications of those to whom accounting tasks are outsourced,

our study is the first to discuss the complementary versus substitutive

role of auditing in a small company setting. Third, our study contrib-

utes by examining drivers of voluntary audit related to agency con-

flicts with owners (the legal form of the company, the existence of a

supervisory board, and the status as a subsidiary) that have not yet

been documented in prior research. By investigating the impact of

nonmandated supervisory boards on voluntary audit decisions in small

companies, we also add to the literature (on listed firms) discussing the

complementary/substitutive relationship between governance mecha-

nisms and external auditing.

The remainder of our paper is organized as follows. In Section 2

we provide a brief description of the institutional and regulatory set-

ting (Germany). We discuss relevant prior literature and develop our

hypotheses in Section 3, followed in Section 4 by a description of

the data and models used in our empirical tests. Results from these

tests are reported in Section 5. Thereafter, our paper concludes with

a brief summary of the main findings and implications in Section 6.

2|INSTITUTIONAL AND REGULATORY

SETTING

Auditing regulation in the member states of the European Community

(EC) or the EU has to comply with EC/EU directives. The Fourth Direc-

tive 78/660/EEC according to Article 51.1(a) in conjunction with Arti-

cle 1 required limited liability companies to have their accounts

audited by one or more persons authorized to carry out such audits.

However, according to Article 51.2, member states of the EC were

permitted to provide an option enabling qualifying companies to

forego the statutory audit. According to Article 11 in conjunction with

Article 12, such qualifying companies were those that did not exceed

two out of three size thresholds—only the maximum thresholds that

member states could set were specified—regarding total assets, turn-

over, and the average number of employees in two consecutive finan-

cial years. In 2013 the Fourth Directive was replaced by Directive

2013/34/EU. This new directive according to Article 34.1 in conjunc-

tion with Article 1 requires limited liability companies that are

medium‐sized, large, or of public interest to have their accounts

audited. As with requirements from the Fourth Directive, there could

also be companies that do not need to have their accounts audited,

therefore, unless they are of public interest or, according to Article

3.2 in conjunction with Article 3.10, exceed two out of three size

thresholds regarding total assets, turnover, and the average number

of employees in two consecutive financial years. As can be seen,

depending on member states' interpretations of the directives, differ-

ent settings can exist within the EU, first due to various definitions

of the size criteria for small companies and second due to a possible

option for qualifying companies to forego a statutory audit.

504 WEIK ET AL.