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    Do Private Company Targets that Hire Big 4 Auditors Receive...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes 
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    Title:
    Do Private Company Targets that Hire Big 4 Auditors Receive Higher Proceeds?
    Practical Implications:

    The primary contribution of this case is to show that valuation multiples are higher for private firms with a Big 4 auditor. The results also provide private sellers with evidence of the impact of audit choice. They demonstrate that the reason for the discount paid for private firms relative to public firms goes beyond simple differences in liquidity as many people believe choice on the cost of capital. Second, this article presents a rigorous study of the PCD in the context of controlling interests, which is needed because, the existing analysis is neither comprehensive nor thorough enough to answer once and for all the question of whether private-firm controlling interests sell for less.

    Citation:

    De France, G., Gavious, I., Jin, J. Y., & Richardson, G. D. 2011. Do Private Company Targets that Hire Big 4 Auditors Receive Higher Proceeds? Contemporary Accounting Research 28 (1): 215-262.

    Keywords:
    private companies, valuation, liquidity, auditors
    Purpose of the Study:

    This study documents a substantial impact of Big 4 auditor choice on the sale proceeds of controlling interests of U.S. private firms. Prior research suggests that Big 4 auditors provide higher audit quality than non-Big 4 auditors for U.S. public companies. Further, Big 4 auditors reduce the cost of equity capital, the cost of debt capital, and increase initial public offering (IPO) proceeds for U.S. public companies. Relative to U.S. public companies, private companies in the sample are small and have poor information environments. Hence, the private company setting is an especially important one when examining the relation between Big 4 auditor choice and perceived audit quality. This study is to explore whether the private company discounts (PCD) declines when the private seller engages a Big 4 auditor, consistent with higher quality audits. The primary focus of the study, however, is to explore whether the PCD declines when the private seller engages a Big 4 auditor, consistent with higher quality audits. Such a finding would point to at least one explanation for the PCD, namely, the information quality facing the buyer. A lower PCD for private sellers engaging a Big 4 auditor implies higher sale proceeds for such firms.

    Design/Method/ Approach:

    The source of the private-firm valuation data is Pratt’s Stats which includes data on the sale of privately held firms for the period 19942005. The sample, limited to the U.S., consists of 3,196 firms, of which 673 are private stock sales, 274 are private asset sales, and 2,249 are public stock sales. Most of the analysis uses a slightly smaller sample (664 and 271 private stock and asset sales, respectively, and 2,225 public stock sales).

    Findings:
    • Private companies with a Big 4 auditor are more likely to have strong internal controls, appropriate levels of accounting personnel, other high-quality advisors (such as an investment bank), and a well-planned-in-advance sale.
    • These companies are less likely to have potential contingent tax liabilities.
    • Many buyers will not consider purchasing a company with poor-quality accounting systems and financial statements; the number of potential buyers is correlated with the hiring of a Big 4 auditor.
    • A representative private stock purchase company with median enterprise value ranging from $14 to 18 million experiences a dollar value decrease in enterprise value due to not hiring a Big 4 auditor ranging from $2.0 to $5.2 million. A similar magnitude of "deal value reduction" for private company sales structured as asset purchases was obtained.
    • The results provide a partial explanation for the private company discount (PCD), one related to the information quality facing the buyer rather than the standard reduced-liquidity argument.
    Category:
    Auditor Selection and Auditor Changes