FAR056 – Private Equity Investment in small and mid-sized audit firms: Investigating Partner Incentives, Firm Dynamics, and Client Outcomes

What?

The number of private equity (PE) investments in accounting firms has grown significantly in recent years, both in the Netherlands and globally. This has inevitably attracted attention from the popular press and regulators, often voicing divergent views. Proponents of PE investments see these investments as a chance for audit firms to pay-off legacy obligations and invest more significantly in audit technology, quality management, and new service lines such as sustainability reporting and assurance. These investments may be challenging to pursue using traditional financing methods for small and mid-sized audit firms. Critics fear that PE-investments will lead to an overemphasis on short-term financial goals that may threaten auditor independence and professional integrity.

Why?

Despite the topic’s importance, structural evidence on the impact of PE investments in audit firms is lacking. Although there is academic literature that investigates PE investments in other settings, these results may not translate to the audit profession due to its unique institutional details, such as independence requirements, regulatory oversight and the difficulty of observing the quality of the service delivered. Therefore, we propose a number of research questions aimed at examining the implications of PE investments for small and mid-sized audit firms.

First, we will conduct a descriptive analysis to identify the common characteristics of firms that attract PE investment. We believe these statistics will already provide valuable insights to the profession and regulators, as they will help in understanding the magnitude of PE investments in audit firms. Next, we examine the impact of PE investments at three different levels: the partner level, the audit firm level, and the client level. At the partner level we aim to examine how PE investments affect audit partner incentives. We propose to address this by investigating the effect of PE investments on the likelihood of partner promotions (leavers) and promoted (left) partners’ characteristics, as well as economic incentives of partners (partner income and wealth). At the audit firm level, we focus on the effect of PE investments on the ability to attract and retain talent (licensed auditors), technology investments, and audit firm growth including effects on client portfolio characteristics such as riskiness. We also investigate the effect of PE investments on the audit firms’ competitive position in the market space. At the client level, we investigate whether PE investments in audit firms affect audit quality and audit fees.