Elisabeth Dedman

The Demand for Audit in Private Firms: Recent Large-Sample Evidence from the UK

Abstract Although theory suggests that companies would rationally select into audit even if it were not a legal requirement, many countries impose mandatory audits. This is arguably due to an audit having elements of a public good, which may result in not enough audits being purchased without regulatory intervention. The mandatory nature of public company audit has created problems for researchers wishing to investigate the demand for voluntary audit. Recent events in the UK, however, have provided such an environment. In the UK, private companies must publicly file financial statements and, until recently, they had also to be audited. However, this requirement has now been relaxed for many private companies. We are therefore able to examine the determinants of voluntary audit in a large sample of companies for which we have financial statement data. We analyse a sample of 6274 recently exempt companies, following them for three years post-exemption. We use agency theory and prior evidence to generate our hypotheses and examine them using a more comprehensive set of explanatory variables than has previously been available in the literature. Our results indicate that companies are more likely to purchase voluntary audits if they have greater agency costs, are riskier, wish to raise capital, purchase non-audit services from their auditor, and exhibited greater demand for audit assurance in the mandatory audit regime. We also document a trend away from audit over time. Overall, our results strongly support the idea that companies choose to be audited when it is in their interests to do so.

The impact of voluntary audit on credit ratings: evidence from UK private firms

After a long period of universal mandatory audit, the UK reduced the regulatory burden of private firms by introducing size-based audit exemption in 1994; the size thresholds have subsequently been progressively increased. Both accounting bodies and credit-rating agencies (CRAs) have expressed reservations about this policy, arguing it could diminish user confidence in reported accounting numbers, and lead to a reduction in financial statement quality and credit ratings. Prior research, however, suggests that the managers of small UK companies do not perceive there to be an association between financial statement audit and firm credit score. To provide evidence of any effect on user confidence of making audit optional, we examine the credit scores and financial reporting quality of a large sample of UK private firms which qualified for audit exemption after major threshold changes in 2004. We find that, even though they report lower average profits, companies which retain a voluntary audit enjoy significantly higher credit scores than those which opt out of audit. The results of both conservatism and accruals-based tests indicate that opting out of audit is associated with less conservative financial reporting, consistent with the concerns of the accounting bodies and the CRAs, and providing an explanation for why opt-out firms report higher profits but receive lower credit scores. This study contributes to an important policy debate by providing large sample evidence that the audit does confer benefits to private firms in terms of financial reporting quality, assurance and the credit scores generated from the financial reports.

The Value Relevance and Information Content of Cash and Stock Dividends in China

Due to their unique institutional features, the Chinese stock markets provide an interesting experimental setting in which to examine how cash and stock dividends convey value-relevant information about future performance and future cash dividends. Applying market valuation equations and prediction models to a large sample of Chinese firms from 2003 to 2011 produces several interesting results. When cash dividends are not paid, then stock dividends are positively associated with firm value, and convey information about future cash dividends and future earnings. When cash dividends are paid, however, it is these that convey information about future cash dividends. Following the share tradability reform and convergence with International Financial Reporting Standards, the value relevance and information content of cash dividends are predicted and found to be stronger, while the value relevance of stock dividends weakens over the same time period. Our evidence suggests that, in a weak information environment, where management have limited control over cash dividend distributions, stock dividends play an important role as information conduits.

The Information Content of Regular Dividends and Share Buybacks for Market Value and Future Earnings in the UK

In this paper, we extend previous work on the relationship between corporate distributions and market value. Adopting an information content perspective, we study the relationship between both market value and future earnings and regular dividends and share buybacks, controlling for other accounting variables. Taking insights gained from prior research, we expect that the coefficient of regular dividends will be higher than that for share buybacks in both market value and earnings prediction regression contexts. Our empirical results are consistent with our expectations. The coefficient of regular dividends is significantly higher than that for share buybacks in both market value and earnings prediction regressions on the various samples upon which we estimate the relationships. In additional tests, dividend displacement can be rejected for regular dividends but mainly not for share buybacks. When it can be rejected for share buybacks, it is because share buybacks reduce market value by more than one monetary unit per monetary unit of buyback, not less. Nonetheless, the coefficients of share buybacks in the earnings prediction equations are higher than would be expected given the dividend displacement results in that they are generally positive.

Large Share Price Movements, the Disclosure of News and Corporate Governance: Implications for Disclosure Rules

Purpose – The paper aims to examine the link between firm-level large share price movements, firm-specific company announcements and corporate governance. Stock market regulation in the UK requires firms to disclose new price-sensitive information immediately via official news providers. The paper investigates whether large share price movements are accompanied by firm disclosure. It also investigates whether corporate governance attributes influence the degree of disclosure by firms. Design/methodology/approach – The disclosure measure is constructed by identifying the largest abnormal daily stock returns for sample firms, and then firm-specific announcements in the three-day window centred on the abnormal return day are searched. Corporate governance variables known to influence disclosure practice are then collected and tested to ascertain whether they influence disclosure for positive and negative (good and bad announcements) abnormal returns. Findings – Large share price movements are accompanied by an official share price movement in 45.2 per cent of cases. This rises to 62.9 per cent when new analyst or newspaper articles are included as potential drivers of the abnormal share price return. The higher the proportion of non-executive directors and CEO/chair duality lead to a higher incidence of bad news disclosure, suggesting increased scrutiny works. The higher the level of CEO and board ownership the lower the level of disclosure. Finally, institutional ownership concentration appears to negatively influence the level of disclosure. Originality/value – Higher levels of corporate governance are shown to lead to better firm disclosure. At the same time, the authors find that in almost 40 per cent of large abnormal share price returns no information has come to the market to drive the share price. Thus, the paper has important messages for regulators, who need to investigate why prices often move a long way without accompanying news. Shareholders, particularly institutions, should ensure high levels of disclosure by company directors.

The Information Content of Accounting Accruals when Accompanied by Cash or Stock Dividends

Unusually high accounting accruals are observable to sophisticated investors, who must then decide whether the accruals represent managerial manipulation of reported earnings or an indication of future firm performance. We hypothesise that both cash and stock dividends contain information useful to investors in making this distinction. We use China as our empirical setting, where both cash and stock dividends are common, and where the information environment is relatively weak. We find several interesting results which support out hypotheses: (i) cash dividends are associated with lower levels of abnormal accruals; (ii) when a cash dividend is paid, abnormal accruals are positively associated with current earnings and are predictive of future earnings; (iii) stock dividends are positively associated with abnormal accruals and with future earnings; and (iv) when stock dividends are paid, the market attaches a positive value to abnormal accruals. We also predict and find that it is firms with higher earnings per share growth which are more likely to distribute a stock dividend.

Dividends in China

Why do firms pay dividends? This is a question that has long interested researchers, particularly since the dividend irrelevance proposition of Miller and Modigliani (1961) because, even though their theory (which relies on several assumptions) suggests investors are indifferent between a dollar distributed and a dollar retained in the firm, companies do pay dividends and this seems to be important to investors.