Insider Ownership and Auditor Monitoring: Evidence from Dual-Class Firms

• In Event: Auditing 1

Abstract

We examine the association of insider ownership and the effectiveness of the external audit function in the unique setting of dual-class firms. The effects of insider ownership on the extent of agency problems, and hence the demand for audit quality is ambiguous, because insider ownership exerts two effects: a positive incentive-alignment effect (from cash flow rights) and a negative entrenchment effect (from board control rights). Using a comprehensive hand-collected sample of U.S. dual-class firms, we are able to discern how these two distinct effects of ownership affect audit monitoring effectiveness. We find that insider cash flow rights are negatively associated with audit fees, auditor independence, and the propensity to hire a Big 4 or industry specialist auditor, while insider board control rights, and the extent of disproportionate insider control, display opposite associations. These results are consistent with general agency theory which suggests a decreased (increased) demand for audit quality from incentive-alignment (entrenchment) effects of ownership.

Authors

• Arno Forst, Kent State University

• Barry R Hettler, Kent State University - Kent