Public Equity and Audit Pricing in the U.S.

Brad Badertscher
University of Notre Dame
Bjorn N. Jorgensen
University of Colorado Boulder
Sharon Katz
Columbia University
William Kinney*
University of Texas at Austin

May 3, 2013

ABSTRACT: Does audit pricing of U.S. firms with publicly traded equity differ from pricing of
otherwise similar firms with private equity? The answer is potentially important for evaluating
regulatory regime design efficiency and for understanding audit demand and production
economics. For U.S. firms with publicly-traded debt, we hold constant the regulatory regime,
including issuer reporting mandates as well as auditor responsibilities and practices. We thus vary
equity ownership factors and public securities market factors plus any related de facto litigation
risk and audit demand. In cross-section, we find that audit fees for public equity firms are 12% to
25% higher than fees for similar private equity firms. Time-series comparisons for firms that
change ownership status yield larger percentage fee increases (decreases) for those going public
(private). Results are consistent with substantial incremental audit fees arising from higher auditor
litigation risk associated with public equity ownership.
*

Corresponding Author: Department of Accounting, McCombs School of Business, The University of Texas at
Austin, 1 University Station, Office: CBA 3.226, Austin, TX 78712. Phone: (512) 471-3632. Fax: (512) 471-3904.
Email: william.kinney@mccombs.utexas.edu.
Keywords: public firms, private firms, ownership structure, audit fees, litigation risk
JEL classification: M41, M42, M44
Data Availability: Data are available from sources identified in the paper.
We are grateful for constructive comments by Dirk Black, Jeff Burks, Matt Cain, Qi Chen, Dain Donelson, Jim Fuehrmeyer, Rich
Frankel, Katherine Gunny, Sudarshan Jayaraman, Menon Krishnagopal, Eva Labro, Wayne Landsman, Mark Lang, Stephannie
Larocque, Xiumin Martin, Per Olsson, Zoe-Vonna Palmrose, Jana Raedy, Dave Ricchiute, Katherine Schipper, Doug Shackelford,
Tom Stober, Jennifer Sustersic, Sandra Vera-Munoz, Mike Wilkins, Mike Willenborg, and seminar participants at the University
of Colorado Boulder, University of Connecticut, Duke University, University of Melbourne, University of North Carolina,
University of Notre Dame, Temple University, University of Texas San Antonio, Washington University in Saint Louis, the 2011
AAA Annual Meeting, and the 2012 AAA Midyear Auditing meeting (discussant Paul Chaney). We would like to thank
PricewaterhouseCoopers and the Mendoza College of Business for financial support.

1. INTRODUCTION
In concept, audit fees for a financial statement audit cover audit production cost including normal
profit and the present value of the auditors expected damages arising from the audited financial
statements (Simunic [1980]). In application, these components interact as differential audit effort affects
audit value and cost through the risk of undetected material misstatement and thus the possible
magnitudes and related likelihoods of damages to the auditor via private litigation.1 One source of
private litigation, alleged audit firm violation of federal securities acts, may involve class actions and
substantial legal defense costs, damage payments and damage to audit firms reputations, as well as
bankruptcy declarations (Seetharaman et al. [2002]; DeFond and Francis [2005]; CAQ [2008]).2
Litigation damages to audit firms vary by type of professional service with 78% of actual damage
payments related to audits of public equity firms, 16% to audits of private equity firms (including private
equity firms with public debt), and 6% to non-audit services.3 Regarding potential damages, 94% of the
aggregate is attributable to public firm audits, 5% to private firm audits, and 1% to non-audit services.4
Prior research also finds that lawsuits against auditors of public firms are more frequent and yield larger
damage awards than those against auditors of private firm clients that are not subject to SEC filing
requirements (St. Pierre and Anderson [1984]; Lys and Watts [1994]).

Simunic and Stein [1996] note that the effects of ownership structure, auditor effort, and risk premium, need to be
disentangled before it is possible to conclude whether or not audits are properly priced in the face of higher litigation.
2
The Center for Audit Quality (CAQ [2008]) reports that, from 1996 to 2007, private litigation payments by Big Four U.S.
audit firms for 362 cases totaled $5.66 billion, and 147 claims for damages of $100 million or more for the same period can
be conservatively aggregated at $201 billion (e.g., each of the 37 claims in the tranche between $100 million and $250 million
are truncated and valued at $100 million each). In contrast, aggregate U.S. audit revenue of the same four firms was $13.5
billion (Accounting Today [2010]).
3
In this paper, the terms public, private, publicly-held, and privately-held refer to whether a firms equity is publiclytraded on an organized capital market. For ease of exposition, we refer to firms with private equity and public debt as
private firms while firms with public equity and public debt are referred to as public firms.
4
According the Stanford Law School Securities Class Action Clearinghouse (http://securities.stanford.edu/), which
maintains an index of filings of 3,280 issuers that have been named in federal class action securities fraud lawsuits since
passage of the Private Securities Litigation Reform Act of 1995 (PSLRA), 96% of all federal class action fraud lawsuits were
filed against issuers with publicly-traded equity. Private firms with publicly-traded debt and their auditors are also subject
to federal class action lawsuits (e.g., Stanford securities class action clearinghouse, Nyack Hospital, Docket number: 02-CV03283).

In addition to federal statutory provisions, various state contract and tort laws provide for
different rights of plaintiffs based on ownership structure and the market environment may also play a
role. The high relative liquidity and ownership dispersion of public firms (Katz [2009]) means that more
equity investors may be harmed by defective audited financial statements and may facilitate class action
lawsuits. In addition, readily observable stock price declines for public equity firms may facilitate
initiation of class actions due to the ease with which potential damages from substandard audits can be
quantified. For example, in discussing audit litigation, a knowledgeable defense attorney has said a
stock price decline of 20 percent or more just about guarantees youll be hit by a suit . . . (as cited by
Rivlin [1996], p. 58).
The concentration of realized damage payments and potential damages for audits of companies
with publicly-traded equity raises the question of whether audit fees reflect audit firms higher exposure
to litigation risk and, if so, to what extent is the difference due to extant audited financial reporting
regulatory structure in comparison to ownership factors. Such ownership factors potentially include the
availability of stock prices to quantify investor losses due to defective audited financial statement
information as well as added monitoring value to a broader audience (Ball et al. [2012]). The answers
are important for understanding the economics of audit services by scholars, audit firms, legislators and
regulators interested in regulatory mechanism design for efficient delivery of assurance services to
inform investors as well as analysts and those charged with governance.
In this study, we analyze audit fees of U.S.-domiciled firms with publicly-traded debt over the
period 2000 to 2009 partitioned on whether a firms equity is public or private. Due to their publiclytraded debt, all private firms in our sample are subject to SEC financial reporting regulations and are
therefore required to file financial statements with the SEC in accordance with Sections 13 and 15(d) of

the Securities Exchange Act of 1934 (Katz [2009]; Givoly et al. [2010]).5 Our research design allows
examination of both levels and changes in audit fees across different ownership structures and hence
exposure to litigation risk, while controlling for or holding constant other firm characteristics, including
public debt, legal environment, and SEC financial reporting and audit requirements.
We conduct pooled cross-sectional tests of audit fee levels for public debt firms that maintain
their private equity or public equity structure throughout the period of data availability (we refer to these
as steady-state or non-transition firms). In addition to analyzing fees of private firms relative to public
firms in cross-section, we also estimate the effect of inter-temporal change in ownership structure for
two samples of transition firms: (i) firms with public debt and private equity that become firms with
public debt and public equity, and (ii) firms with public debt and public equity that become firms with
public debt and private equity. This difference-in-differences design holds other firm specific effects
constant to allow examination of how audit fees change as the firm transitions between public and
private equity ownership.
Our results across both non-transition firms and transition firms provide consistent evidence that
relative to private firms, public firms pay substantially higher audit fees. For cross-sectional tests of nontransition firms, we find that public firms pay audit fees that are 12% to 25% higher than private firms
and both statistically and economically significant. For inter-temporal tests of a change in ownership
status, we find that audit fees are significantly higher (increase by 87%) when a firm goes public and
significantly lower (decrease by 47%) when a firm goes private. These inter-temporal change estimates
are consistent with a greater liability loss component embedded in audit fees for public firms relative to

In particular, [u]nder the 1934 Act auditors must prove they acted in good faith (i.e., not grossly negligent, fraudulent or
constructively fraudulent) (Venkataraman et al. [2008], p. 1317).
5

private firms and suggest that audit firms may include a pure litigation risk premium for firms with
public equity.6
Our results are robust to controlling for the Sarbanes-Oxley Act (SOX 2002) section 404(b) that
may differentially affect private equity firms with public debt, after controlling for firm characteristics
such as leverage, credit rating of the firm, occurrence of losses, size, multinational operations, asset
growth, and audit quality. We further control for auditors effort by including the number of words in
the 10-K, presence of goodwill impairments and discontinued operations, and utilizing each firm as its
own control. Finally, we mitigate the role that self-selection might play by conducting both propensity
score matching and Heckmans [1979] sample selection correction procedure. Taken together, these
results imply that the ownership status of an audit client significantly affects audit pricing.
Our study makes several contributions to the existing literature regarding public vs. private
equity firms. First, in contrast to prior research (e.g. Seethataman et al. [2002]; Venkataraman et al.
[2008]; Choi et al. [2009]), our sample of privately-held firms with publicly-traded debt that are subject
to mandatory SEC filings isolates how public equity affects audit pricing, controlling for filing,
disclosure and auditing requirements, and audit effort. Second, as suggested by other researchers, we
are able to quantify the audit fee premium of public equity firms likely due to higher litigation risk for
public firms (Simunic and Stein [1996]; Bell et al. [2001]; London Economics [2006]). Third, even
though private equity firms constitute 99 percent of U.S. companies in number (AICPA [2004]; Katz
[2009]) and make up a significant portion of the audit services market (Chaney et al. [2004]; Minnis
[2011]), little is known about audited financial reporting by U.S. private equity firms and we provide

Cornerstone Research suggests that class action litigation exposure to IPO firms is highest in the first few years and
decreases over time as companies mature and stock price volatility decreases (Cornerstone Research [2010]).

initial insight into the link between public equity and audit pricing in the U.S. (Ball and Shivakumar
[2005]; Allee and Yohn [2009]; Cassar [2009]; Badertscher et al. [2012]).7
Finally, regarding firms changing ownership status, our tests of firms that transition from private
to public and from public to private are the first to document that audit fees are significantly altered
during the period surrounding going-public and going-private transactions. This further corroborates our
main finding that ownership status is associated with audit pricing, likely due to audit litigation risk.
The remainder of this paper is organized as follows. Section 2 discusses the bases for our research
questions regarding audit fees based on structure and environment, while section 3 describes our
research design and sample, including descriptive statistics. Section 4 provides our cross-section and
time-series estimation results and robustness tests and section 5 concludes. All variable definitions are
included in the Appendix.
2. PRIOR AUDIT PRICING RESEARCH AND RESEARCH QUESTIONS
As to audit production cost, audit firms may react to higher audit litigation risk by raising fees
to cover the cost of increased audit production effort in an attempt to reduce the likelihood of material
misstatement or by adding a risk premium to help cover possible future litigation costs (Palmrose [1986];
Simon and Francis [1988]; Pratt and Stice [1994]; Simunic and Stein [1996]). It is also possible that
audit production cost is driven by increased demand for reliable audited information as a means of
adding value via a broad public market (Ball et al. [2012]). Specifically, Ball et al. [2012] suggest that
firms allocate more resources to audited financial statements as a commitment to independent
verification of financial outcomes that allows managers to credibly disclose private information that is
costly for investors or auditors to verify directly.

Hope and Langli [2010] and Hope et al. [2012] test auditor independence and audit effort in various agency settings for
private firms in Norway, which are characterized by low litigation environment, and hence not appropriate to directly test
for litigation risk; the results are not easily generalized to the U.S.

In our setting, public equity firms do (are likely to) provide more voluntary disclosures in the
form of management forecasts (conference calls) due to the disperse equity ownership and the
correspondingly greater information demand. However as Ball et al [2012] point out, voluntary
disclosure beyond financial reporting requirements is typically associated with litigation against the
managers and not the auditors, and therefore seems unlikely to have a substantial production effect on
audit fees. Similarly, Field et al. [2005] conclude that voluntary disclosures by management reduce
litigation risk. In contrast, audited financial statements may play a more important monitoring role for
private firms because they lack a market base measure of firm value, have less vulnerability to takeovers,
and less disclosure of non-accounting information (Lennox [2005]). Therefore, the demand for audited
financial statements may be potentially as important for public equity firms as it is for private equity
firms.

Nonetheless, the issue of demand for verified information versus supply of the verified

information is difficult to disentangle because higher litigation risk associated with public equity is
intrinsically linked to the public equity holders as discussed in section 4.4.
Prior research has isolated aspects of the relation of regulatory structure on audit litigation and
audit fees, but has been unable to hold constant firm characteristics, regulatory reporting, and audit
requirements. In concept, higher litigation risk and thus higher audit fees might be expected for public
firms audits compared to private firms, because public firms market liquidity and ownership dispersion
are higher (Katz [2009]) so more equity investors may be harmed by misrepresentation in audited
financial statements. The 2008 CAQ report suggests increasing difficulties for audit firms in dealing
with potential liability from equity market capitalization declines of audit clients because potential
damages in securities class action typically begin with a decline in large market capitalization associated
with an alleged misrepresentation. Jones and Weingram [1996] find that the proportion of shares traded,

market capitalization, and share price declines all contribute to litigation exposure.8 More recently,
Lowry and Shu [2002] find that potential litigation costs for initial public offering (IPO) firms are
substantial, with settlement payments averaging 11% of total proceeds raised from the IPO. They also
document that, among IPO firms, those with higher litigation risk underprice their offerings more and
that more underpricing lowers expected litigation costs. Moreover, Lockyer [2008], Shore [2007], Wiles
[1998], and Chase [1988] each provide evidence of a securities lawsuit brought against a firm as the
result of a decrease in their stock price. Finally, leading insurers of audits of smaller audit firms (e.g.,
Aon Corporation) consider public vs. private ownership status of audit clients as an important factor in
determining an audit firms litigation risk (CAQ [2008]).
Based on the audit demand and litigation risk studies above as a whole, one might expect audit
fees to be higher for public firms than for private firms. In contrast, on the audit production side, similar
audit work effort requirements and litigation risk (and thus similar audit fees) might be expected for
public and private firms audits. As to regulation and enforcement, because all of our sample firms are
issuers of registered publicly traded securities, SEC and PCAOB reporting and audit requirements and
policies for public debt firms are the same as public equity firms. Consistent with this view, results
(untabulated) indicate that firms with public debt are reviewed by the SEC at the same frequency as
firms with public equity.9 Additionally, under the Sarbanes-Oxley Act, the PCAOB is charged with
inspection of audits of issuers of public securities that does not distinguish those who issue public debt
versus public equity securities.

Finally, PCAOB Auditing Standards do not distinguish audit

requirements or audit effort of public equity and public debt-only issuers.

The PSLRA was aimed at reducing opportunistic lawsuits, often filed within days of a stock price drop. While the PSLRA
changed some of the ground rules for commencing and prosecuting such lawsuits, it did not diminish the volume of lawsuit
appreciably (Giuffra [1999]) but rather shifted the lawsuits to the state courts (Rosen [2009], Post [2012]).
9
We use the filing type UPLOAD and CORRESP on SEC.gov to determine the frequency of SEC reviews.

To better understand how ownership structure might affect audit effort in practice, we asked
policy-level partners at each of the Big Four audit firms whether their audit manuals differentiated audit
effort of public equity issuers from public debt issuers. As an example, we asked whether the material
amount used to plan audits varied between public equity and public debt firms vs. private equity and
public debt firms. The slightly paraphrased view of audit partners at three of the largest four audit firms
was, For public issuers of debt or equity securities, our starting point is 5% of net income -- the lower
end of our policy manuals range of 5% to 10%. The fourth firm agreed, but allowed flexibility to use
10% for public debt-only issuers.
We also asked engagement-level partners to describe their own application of standards and audit
manual guidance on particular engagements. One expressed view was that practitioners typically use
10% of net income for public debt because of a perception that a public debt issue is less risky than a
stock registrant. As for a transition firm, a retired audit partner stated I was the partner on a debt-only
registrant and after it became a stock registrant, our materiality level did go down which pressured me
as a partner to get the fees increased. Further, the partner stated Its not said anywhere, but in my
experience the driver behind the use of lower materiality thresholds and the attendant increased testing
for public companies was related to litigation risk.
Finally, Bell et al. [2001] and London Economics [2006] use confidential audit firm data on audit
effort and pricing as well as assessments of client engagement risk. These studies document that despite
higher business risk for the auditor, audit firms are not likely to be able to pass on the full cost due to
public market price competition. Taken together, audit regulatory regimes and available data on audit
production practices, one might expect U.S. audit fees to be somewhat similar for public and private
equity firms.

Differences in audit effort and audit pricing under different regulatory and legal regimes have
been identified by recent cross-country research studies. Seetharaman et al. [2002] report higher audit
fees paid by U.K. firms that are cross-listed in the U.S., consistent with the increased liability and
litigation costs in the U.S. Choi et al. [2009] extend this research to 14 countries and document that
auditors charge higher fees for firms that are cross-listed in countries with stronger legal regimes than
they do for non-cross-listed firms. Choi et al. [2009] interpret their results as supporting the theory that
audit fee premiums are associated with increased legal liability and not with increased audit
complexity.10
In contrast to cross-country research, Venkataraman et al. [2008] use a litigation and regulatory
regime change during an IPO to examine the relationship between auditor exposure to legal liability,
audit quality, and audit fees. They study 142 IPOs between 2000 and 2002 to compare the financial and
associated audit fees for the two years prior to the IPO (pre-IPO), in accordance to prospectus filings,
which are subject to the Securities Act of 1933, to the year of IPO (post-IPO), in which firms report
filings under the Securities Exchange Act 1934. Venkataraman et al. [2008] find that auditors provide
higher quality audits (measured by lower abnormal accruals) and receive higher audit fees for the preIPO audits under the Securities Act of 1933 due to their exposure to higher litigation risk.11

10

Skinner and Srinivasan [2012] find that, while audit fees in Japan are low compared to those in the U.S., cross-listed
Japanese firms pay significantly higher audit fees than comparable U.S. firms, which they interpret as supporting the idea
that audit quality in Japan is generally lower than in the U.S. Furthermore, in cross-country studies, factors other than
litigation risk, such as cross-country differences in audit competition, relative bargaining power of auditors and clients, and
audit quality levels could explain audit pricing differences (Sankaraguruswamy and Whisenant [2009]) and to the extent that
the results based on samples consisting of foreign companies generalize to U.S. firms is not clear due to differences in these
countries reporting regimes (Givoly et al. [2010]).
11
The authors acknowledge that auditors responsibilities are higher for IPO engagements and hence can lead to higher fees,
but proxy for the portion associated with the litigation risk by utilizing the existence of audit committee, the change in
auditors, the S-1 filings, the number of amendments to S-1 registration, and the log of gross proceeds.

Our study complements and extends Venkataraman et al. [2008] by examining a sample of firms
that have identical reporting requirements across two different ownership structures. 12 Similarly, our
results may not generalize to their setting. Since Venkataraman et al.s [2008] results focus on the period
of change in regulation regime, their results cannot easily be generalized to the comparison of private
firms with public debt versus public firms with public debt, who are subject to identical reporting
regulation regimes. Four other studies are more direct in their comparison of public and private equity.
First, in contrast to archival studies, Palmrose [1986] collected survey data for a sample of 361 audits
between 1980 and 1981 where 25% of the firms were privately held with no public debt and therefore
not required to comply with SEC reporting and audit requirements. Palmrose finds that public firms had
higher audit fees. This finding, however, can be also attributed to the different reporting requirements
and effort by auditors and is not solely tied to litigation and business risk. Second, the client acceptance
decision literature finds that audit firms consider public status as a business risk of auditor reputation
loss (Palmrose [1986]; Bell et al. [2002]; Johnstone and Bedard [2003, 2004]). Finally, Chaney et al.
[2004] investigated audit pricing among U.K. private firms and document that private firms choose the
lowest-cost auditor available and that Big 5 audit firms are not able to charge a premium to private firms.
Given the prior research, it is not clear whether public equity and the attendant regulatory and
market environments play a role in the pricing of audit fees, and if so, to what extent. We pose three
empirical questions based on regulatory reporting and audit regimes and other things equal:
Q1: Are audit fees significantly different for public vs. private equity firms?
Q2: Does going public significantly increase audit fees?
Q3: Does going private significantly reduce audit fees?

12

Other related studies focus on specific attributes of the IPO process. Beatty [1993], for a sample of 1,191 IPO firms between
1982 and 1984, reports a positive relation between non-underwriting expenses, as a proxy for audit fees, and three ex-post
measures of litigation risk: delisting, bankruptcy and lawsuits. Willenborg [1999] shows that IPO audit fees increase with
the IPO proceeds, since these proceeds stand for the upper limit on damages, and associated with their insurance role.

10

We will address all three questions using a single sampling frame of U.S. firms with public debt.
3. RESEARCH DESIGN, SAMPLE, AND DESCRIPTIVE STATISTICS
3.1 Research Design
Because their debt is publicly-traded, private equity firms with publicly-traded debt must file
Form 10-K audited financial statements with the SEC, even though their equity is privately-held. We
use the population of publicly-traded debt firms in a research design that enables us to hold constant
SEC filings, disclosure requirements, and basic audit requirements, but vary the ownership structure of
the audit client and hence exposure to the audit firms litigation risk. We address Q1 by comparing audit
fees of private equity and public debt firms that maintain their private equity status with otherwise
similar firms having public equity and public debt. In particular we compare, in cross-section, our
sample of non-transition or steady-state private firms to all public firms with public debt as well as to a
propensity matched sample of firms with publicly-traded debt and equity based on industry, year,
leverage, abnormal accruals, sales, assets, and foreign operations.
To address Q2 and Q3, we estimate the audit fee effect of inter-temporal change in ownership
structure as private equity firms transition to public firms (going-public transactions), and as public firms
transition to private firms (going-private transactions). This difference-in-differences design holds firm
effects constant and allows examination of how audit fees change as firms change ownership status.
Figure 1 illustrates the sample frame and sample selection process and includes the corresponding figure
and tables showing results.
[PLACE FIGURE 1 HERE]
3.2 Sample Selection
To establish our sampling frame, we follow Katz [2009] and Givoly et al. [2010] and select all
firm-year observations on Compustat in any of the ten years from 2000 through 2009 that satisfy the

11

following criteria: (1) the firms stock price at fiscal year-end is unavailable (i.e., SEC filings are
available, but not year-end stock price); (2) the firm has total debt as well as total annual revenues
exceeding $1 million; (3) the firm is a domestic company; (4) the firm is not a subsidiary of another
public firm; and (5) the firm is not a financial institution or in a regulated industry (SIC codes 6000
6999 and 48004900).
To ensure that our initial sample includes only private firms with public debt, we examine each
firm and remove firms with only historical prospectus information, firms with public equity, firms
lacking required financial statement data, firms involved in bankruptcy proceedings, foreign-domiciled
firms, and firms that lack audit fee data on Audit Analytics. Details are provided in Table 1 and Figure
1. The resulting initial sample consists of 229 private firms (772 private firm-years) with public debt
between 2000 and 2009.
For Q1 analyses we limit our sample to steady-state (non-transition) firms that remain private
during the sample period. This limitation generates a sample of 162 firms with 628 firm-year
observations. We compare this sample of private firms to the frame of public firms with public debt and
to a propensity matched sample of public firms with public debt. Following Givoly et al. [2010], we
establish the presence of public debt in a given year based on one of the following indications: (1) the
availability of S&P senior debt ranking (Compustat item SPLTICRM), (2) the existence of debt
debentures (DD), or (3) the issuance of public debt (according to the Mergent Fixed Income Securities
database (FISD) and Thomson Reuter SDC database), prior to the observation year with a maturity date
beyond the observation year. Applying the above criteria generates a final sample of 1,950 distinct public
equity firms (11,322 firm-year observations) with publicly-traded debt.
Some characteristics that affect private versus public ownership choice may also affect audit
fees, so we develop a propensity score to obtain a matched sample. In particular, we first match public

12

firms in the same industry (three-digit SIC code) and fiscal year as the private firms. We create
propensity scores derived from a probit model that includes control variables that significantly differ
between the two groups: leverage (LEV), abnormal accruals (ABNACC), size (ASSETS), and foreign
operations (MNC). We then match each private firm, one-to-one, with a public firm with the closest
propensity score, without replacement (for further discussion see Angrist and Pischke [2009]). This
matching procedure reduces the concern that our results are driven by differences such as leverage,
earnings quality, size, and foreign operations between public and private firms. As a result of this
matching process, both samples include 427 firm-year observations.
[PLACE TABLE 1 HERE]
For the Q2 and Q3 analyses we limit the initial sample of private firms to those firms that
transition between private equity and public equity ownership during the sample period and hence have
both private and public ownership phases. This limitation generates a sample of 67 firms with 392 firmyear observations, of which 248 are public and 144 are private. In order to maximize subsample size,
when audit fee data are not available on Audit Analytics, we hand-collected the audit fee data from
proxy statements (or 10-K filings if not disclosed in proxy statements). As indicated in Table 1, the final
transition sample consists of 44 firms (144 public and 90 private firm-years) that transition from private
to public and 23 firms (104 public and 54 private firm-years) that transition from public to private.
3.3 Descriptive Statistics for Public and Private Firm-Years
Table 2, Panel A presents descriptive statistics for our sample of private firms with public debt,
that remain private, as compared to all public equity firms with public debt. Both means and medians of
AUDIT and the mean of AUDIT_S are statistically smaller for private firms than for public firms. Where
AUDIT is the raw audit fee and AUDIT_S is the audit fee (converted to millions) scaled by total assets.
The AUDIT_S results indicate that, on average, private firms exhibit significantly lower audit fees

13

relative to public firm by 13.7% (0.00133/0.00117). We find mixed evidence of a statistical difference
between total fees of public and private firms, with the raw total fees (TOTAL) indicating a significant
negative difference while the scaled total fees (TOTAL_S) indicates a significant positive difference.
The statistics for leverage indicate that private firms have significantly higher leverage ratios
(LEV is 0.70 vs. 0.31) than public firms, and private firms are more likely to report current year losses
(LOSS). Private firms exhibit significantly lower total assets, number of business segments, and foreign
operations (ASSET, SEG, and MNC, respectively) compared to public firms. Private firms also have
lower word count in their 10-K filings (WORDCT). Fewer private firms operate in litigious industries
(LIT), are audited by Big 4 auditors (91% and 93% for private firms and public firms, respectively), and
were involved in class action lawsuits (POST_LS).
Regarding SOX 404(b) audits of internal controls that were required for larger public equity
firms beginning in late 2004, the overall rate of application by private firms for our ten year period is
4% versus 53% for public firms. Consistent with fewer private firms applying SOX 404(b), fewer
private firms also report internal control weaknesses (M_WEAK). Panel A also suggests that private
firms exhibit lower abnormal accruals (ABNACC) relative to public firms, which is consistent with
results in Givoly et al. [2010]. Public and private firms exhibit similar amounts of goodwill impairments
(GW_IMP) and discontinued operations (DISCON_OP). However, private firms do have statistically
larger amounts of comprehensive income adjustments (CI_ADJ) and lower credit quality as indicated
by the higher BONDRATE (Gul and Goodwin [2010]). In sum, the results in Table 2, Panel A suggest
the importance of controlling for client and audit firm characteristics, as well as for other factors that
may affect audit litigation risk when comparing the audit fees of public and private firms.
[PLACE TABLE 2 HERE]

14

Table 2, Panel B presents the Pearson and Spearman correlation tables for our variables of
interest. Consistent with public firms having higher audit fees, both the Pearson and Spearman
correlations between our indicator variable for public equity (PUBLIC) and our two measures of audit
fees (AUDIT, AUDIT_S) are positive and significant. In addition, PUBLIC is positively related to the
number of operating business segments (SEG), multinational corporations (MNC), fewer loss years
(LOSS), lower leverage (LEV), higher assets (ASSETS), abnormal accruals (ABNACC), involvement
in class actions lawsuits (POST_LS), greater number of words in their 10-K (WORDCT), lower auditor
turnover (AUD_TO), and more likely to apply section 404(b) of SOX (SOX404). Finally, consistent
with public firms having higher credit ratings we find a large negative correlation between PUBLIC and
BONDRATE.
Univariate results for private firms relative to the propensity matched sample of publicly-traded
firms with public debt are in Table 3, Panel A. The results indicate that private firms have statistically
significantly lower audit fees and total fees (AUDIT, AUDIT_S, TOTAL, and TOTAL_S). By
construction of the matching process, private firms significantly differ from matched public firms across
fewer firm characteristics, all with lower economic significance, including leverage (LEV, 56% and
48%, respectively). Relative to public firms, private firms (1) are more likely to be audited by Big 4
auditors (BIGAUD), (2) are subject to less audit turnover (AUD_TO), (3) have fewer class action
lawsuits (POST_LS), (4) are less likely to apply section 404(b) (SOX404), (5) report fewer material
weaknesses (M_WEAK), and (6) have smaller amounts of goodwill impairments (GW_IMP).
4. ESTIMATION RESULTS AND ROBUSTNESS TESTS
4.1 Model:
Our basic regression specification for both our Q1 cross-section and Q2 and Q3 inter-temporal
analyses is the following:

15

FEESi,t = 0 + 1PUBLICi,t + 2INVRECi,t + 3ASSETS_GRi,t + 4BIGAUDi,t

+ 5SEGi,t + 6MNCi,t + 7LITi,t + 8LOSSi,t + 9LEVi,t + 10ASSETSi,t
+ 11ABNACCi,t + 12POST_LSi,t + 13AUD_TOi,t + 14WORDCTi,t
+ 15SOX404i,t + 16M_WEAKi,t + 17GW_IMPi,t + 18DISCON_OPi,t
+ ttYEARt + kkINDUSi + i,t .

(1)

The dependent variable, FEES, represents either the natural logarithm of audit fees or total fees.13
We include an indicator variable, PUBLIC, which equals one for public equity and public debt firms,
and zero otherwise. If public firms are subject to higher audit fees, then the coefficient on PUBLIC
should be positive.
We also include variables to control for factors that affect audit fees, as documented by prior
research, including client firm characteristics as well as characteristics of the audit firm. Following Kim
and Skinner [2012], growth in assets (ASSET_GR) is potentially associated with litigation risk due to
significant changes in transaction cycles and overburden on clients financial control and this could
impact audit fees. We include a number of control variables for the firms complexity, including the
fraction of assets in inventories and receivables (INVREC), the number of operating business segments
(SEG), indicator variable for foreign operations (MNC), goodwill impairments (GW_IMP), and
discontinued operations (DISCON_OP). Our final complexity measure is the number of words in the
10-K (WORDCT). Prior research by Loughran and McDonald [2011] suggest that the number of words
in a 10-K proxies for the complexity of the firm. Auditor type (BIGAUD) can reflect greater expertise
and hence command higher audit fees.
Section 404(b) of the Sarbanes-Oxley Act (SOX) presents a substantial audit requirement that
differentially affects public equity firms. Specifically, SOX 404(b) requires independent audits of

13

Our main focus is on audit fees and total fees but we also examine audit fees plus audit-related fees to provide additional
evidence on the role that public equity has on fees paid to the audit firm as Schmidt [2012] notes an association of non-audit
fees (which consist of audit-related, IT, tax, and other fees) with litigation risk. Our results are qualitatively similar to those
presented in Table 3 if we examine audit plus audit-related fees. Finally, results (untabulated) are also qualitatively similar
if we use audit fees or total fees scaled by assets as the dependent variable.

16

internal controls over financial reporting for larger public equity firms (firms with greater than $75
million in public float) and some private firms choose to have such audits. Given the documented audit
costs of section 404(b) (Iliev [2010]; Kinney and Shepardson [2011]) and to ensure that section 404(b)
type audits are not driving our results, we include an indicator variable (SOX404) if the audit firm
conducted an internal control audit.14 Prior research also suggests that firms with material weaknesses
in internal control have complex operations, higher accounting risk, financial stress, and poorer
accounting quality (Ashbaugh-Skaife et al. [2007]; Doyle et al. [2007]). Hence, we identify firms with
ineffective internal controls (M_WEAK) as this is likely linked to additional audit effort and fees.
Loss (LOSS) and leverage (LEV) are proxies for the financial strength of the client firms and
client-specific litigation risks borne by the auditors. The litigious industry-based indicator variable
(LIT), as in Francis et al. [1994], controls for any auditors fee premium for more litigious industries.
Similarly, to control for the potential of increased audit fees due to securities class action lawsuits we
include an indicator variable (POST_LS) that equals one if the client firm was involved in a class action
lawsuit in year t-1, according to the Stanford class action clearinghouse database. The natural logarithm
of total assets (ASSETS) is used as a proxy for the client firm size. We further include year (YEAR) and
industry (INDUS) fixed effects to control for fundamental differences in audit fees that may exist across
years and industries.
Heninger [2001] reports that the risk of auditor litigation is positively associated with abnormal
accruals. In addition, Venkataraman et al. [2008], who use abnormal accruals as a proxy for audit
quality,15 document that an increase in litigation risk increases both audit fees and audit quality.
Therefore, to the extent that our firms exhibit different abnormal accruals between ownership phases,

14

Private firms, including those with public debt, are not subject to SOX 404(b). However, our results suggest that
approximately 11% of private firms with public debt voluntarily adopt SOX 404(b).
15
Abnormal accruals were commonly used in prior literature as a proxy for audit quality (Becker et al. [1998]; Francis and
Krishnan [1999]; Frankel et al. [2002]; Myers et al. [2003]; Sankaraguruswamy and Whisenant [2009]).

17

we need to control for it. Ball and Shivakumar [2005] and Givoly et al. [2010] find that public firms
recognize losses in a timelier manner and engage in more earnings management than private firms. Thus,
we control for both timely loss recognition and abnormal accruals by including ABNACC. ABNACC
is the amount of abnormal accruals after controlling for conservatism (Ball and Shivakumar [2006]).
Finally, as a result of prior research by Maher et al. [1992] who document that audit fees increase when
a firm changes auditors, we include an auditor turnover indicator variable for the firms that change
auditors (AUD_TO).16
For Q2 and Q3 analyses, which examines firms that transition between private equity and public
equity ownership, we also include in equation (1) indicator variables for the year of IPO (YEAR_IPO)
or the year of going private (FIRSTYEAR_PRV). These event timing indicator variables isolate specific
corporate events that increase the litigation risk and effort required by the auditors. Finally, we include
firm fixed effects (FIRM) when examining our transition sample to alleviate concerns that our results
are driven by specific firm characteristics.
4.2 Q1 Results: Cross-section Comparison of Private Firms with Public Firms
We present the Q1 steady-state regression results for tests of audit fees for public and private
firms in Table 3 (for the full sample) and Table 4, Panel B (for the propensity matched sample). The
first column of each table exhibits the application of equation (1) to explore the impact that ownership
structure has on the natural logarithm of audit fees after considering the effect of other factors that likely
impact the cost of the audit. The results indicate that public firms exhibit higher audit fees than private
firms, after controlling for important client firm and audit firm characteristics. For the full sample

16

In an untabulated analysis we further control for other factors related to the operations of the firm as well as those suggested
by Kim and Skinner [2013] including sales growth, profitability, volatility of sales, volatility of return on assets, tangible
assets, R&D intensity, capital expenditures, comprehensive income adjustments (CI_ADJ), which are available on
COMPUSTAT only since 2004, and bond ratings (BONDRATE), which are not available for all observations. While results
remain qualitatively similar the benefit to R-square is marginal.

18

(propensity matched sample) the estimated coefficient on PUBLIC is 0.116 (0.220) and significant,
consistent with audit fees being 12% (25%) higher due to the higher litigation risk.17,18 Although we
cannot say for absolute certain that our finding are due to litigation risk, as there is no direct test for
litigation risk, our results consistently suggest that litigation risk is the reason for the higher audit fees.
Moreover, we include numerous control variables that prior literature has deemed relevant to audit price,
perform numerous robustness tests, and apply a variety of econometric techniques to rule out other
possible links. Irrespective of how we examine the data, our results continue to suggest that the heighten
litigation risk for publicly held equity firms is the key driver of our results.
[PLACE TABLE 3 and TABLE 4 HERE]
Most control variables in Table 3 and Table 4, Panel B, have coefficients that are significant and
in the direction consistent with a positive association between audit effort and audit litigation risk and
audit fees. The coefficients on the fraction of assets in inventories and receivables (INVREC), client
firm size (ASSET),19 foreign operations (MNC), number of operating business segments (SEG), and
word count (WORDCT), each of which proxies for required effort by the audit firm, are significantly
positive. The coefficient on leverage (LEV) is significantly positive, indicating that financial weakness
of the client firm and higher litigation risk could lead to higher audit fees. Similarly, losses (LOSS) are
positively correlated with audit fees. Increase in litigation risk as captured by class action lawsuits
(POST_LS) and weakness in internal control (M_WEAK) are positively correlated with audit fees in

17

Since PUBLIC is an indicator variable and the dependent variable is the natural logarithm of audit fees, the calculation of
the percentage increase in fees for public firms as compared to private firms is e0.116 = 1.123 in Table 3.
18
As an alternative to using the propensity matched score procedure we also applied two-way common support to our public
and private non-transition sample to assure that all covariates have similar ranges of values. Our results indicate an estimated
coefficient on PUBLIC of 0.128 (t-statistic = 4.62), consistent with audit fees being 14% higher, which is very similar to the
results in Table 3.
19
To address the concern that the relation between audit fees and assets is non-linear and its potential effects on our results
we re-ran Table 3 based on tercile of assets. Untabulated results indicate that the coefficient on PUBLIC is positive (ranging
from 0.100 to 0.164) and significant in all five terciles (all t-statistics are greater than 1.65) and does not significantly differ
among the terciles.

19

the full sample. As further expected, big auditors charge higher audit fees (BIGAUD), however, change
in auditors (AUD_TO) is negatively correlated with audit fees in the full sample but has no statistically
significant impact on audit fees in the propensity matched sample.
Especially relevant to consideration of the structure of audited financial reporting is the audit
pricing effect of SOX 404(b) audits as private equity firms are exempt from internal control audits.
Consistent with the literature documenting higher audit fees due to applying internal control audits under
section 404(b) of SOX (Iliev [2010]), the estimated coefficient on SOX404 is statistically significant
and positive at 0.404 (or 49% increase in audit fees) for the full sample and 0.677 (or 97% increase in
audit fees) for the propensity matched sample. The latter coefficient corresponds with other evidence
that audit fees typically doubled when public companies first apply SOX 404(b) (Kinney and
Shepardson [2011]).20
The regression results found in Tables 3 and 4 indicate that public firms have higher audit fees
as well as higher total fees relative to a sample of private firms. In addition, the estimated coefficients
on PUBLIC are statistically significant and economically important for both types of fees.21
4.3 Q2 and Q3: Audit Fees around Going-Private and Going-Public Events
Descriptive statistics and audit firm fees for firms that transition between private and public equity

20

By implication, a private firm that were to become a public firm would face two compounding effects on its audit fees, the
12% (or 25%) additional audit fee premium related to PUBLIC as well as the 49% (or 97%) additional audit fee premium
due to audit effort related to SOX404.
21
Given our findings that the estimated OLS coefficient on PUBLIC is statistically significant, we examine the potential
impact of unobserved confounding variables using the approach of Larcker and Rusticus [2010] and Frank [2000].
Specifically, we calculate the Impact Threshold for a Confounding Variable (ITCV). If the ITCV is high, the OLS results are
robust to omitted variable concerns. Following Frank [2000], our ITCV is determined to be 0.025, implying that the
correlations between audit fees and PUBLIC with the unobserved confounding variable each only need to be about 0.158
(=0.025) to overturn the OLS results. It is also slightly smaller than the calculated impact that SOX404 (0.028) has on our
results. Therefore, we would need a confounding variable with as strong of an impact on audit fees as SOX404 to overturn
our results on PUBLIC. As noted by Larcker and Rusticus [2010], ITCV is a very useful evaluation procedure for the OLS
estimates but impact thresholds are difficult to establish and so our results should be viewed with caution.

20

Prior research documents that organization structure changes such as going public and going
private can affect earnings quality in time periods surrounding those transactions. For example, Ball
and Shivakumar [2008] and Katz [2009] provide evidence that private firms alter their earnings quality
several years before public stock exchange listings, in anticipation of increased scrutiny by regulators
and public investors. Thus, we examine whether audit firms adjust their fees in the periods surrounding
going-private and going-public transactions. Such changes in audit fees could be the consequence of
anticipated changes in stock ownership concentration, financial reporting pressures, reliance on more or
less debt financing, earnings quality, and overall audit litigation risk. More specifically, Venkataraman
et al. [2008] document that, in the years prior to an IPO, when their (but not our) firms are subject to the
Securities Act of 1933, auditors are associated with lower abnormal accruals. Auditors also receive
higher audit fees for their additional responsibilities and higher audit litigation risk under the 1933 Act,
relative to the IPO year, when firms file audited reports subject to the Securities Exchange Act of 1934.
These findings imply that their pre-IPO private firms without public debt may pay higher audit fees than
their public firms during the IPO year.
In contrast, we expect the changes in audit fees in the periods surrounding the going-private and
going-public transactions to reflect the broader differences in audit fees that we document for public and
private firms. However, we have no predictions for how quickly the changes will occur. Thus, we
examine two years before and two years after the going-private and going-public transactions.
Figure 2, Panel A, presents the average audit and total fees for firms with public debt and private
equity that issue an IPO. This figure is centered on the two years preceding and the two years after a
private firm goes public. The plot of AUDIT suggests a substantial and monotonic increase in audit fees
beginning one year before the IPO until one year after the IPO. These results are consistent with the

21

increase in audit fees during the public ownership transition phase.22 In contrast, TOTAL increases in
the year preceding the going-public transaction (untabulated results indicate this increase is primarily
due to tax and audit-related fees) and begins to decline to the pre-IPO level in the year after the IPO,
consistent with an increased need for audit-related services (e.g., compliance with SOX) as well as taxconsultation before such going-public transactions (Badertscher et al. [2012]).
[PLACE FIGURE 2 HERE]
In addition to presenting the audit and total fees for the transition firms, Figure 2, Panel A, also
presents audit and total fees for a matched sample of private firms that do not transition to public equity
ownership. The match is conducted in year t-1 and the matched sample remains constant throughout the
time period. The match is based on the same fiscal year, industry (3-digit SIC code), and closest
propensity score match, where propensity score match is based on leverage, abnormal accruals, sales,
assets, and foreign operations. The average percentage change in audit fees from year t-1 to t+1 for the
transition sample is 70.7% while the average change in audit fees over the sample period for the nontransition matched sample is 6.7%. The difference in percentage change in audit fees is 64% which is
statistically significant at the 1% level. The results provide additional support that public equity
ownership significantly affects audit fees.
Figure 2, Panel B, presents the mean values for audit and total fees in the two years preceding
and the two years after a public firm is taken private. The plot of audit fees suggests a substantial
decrease in audit fees in the year of the going-private transaction. In contrast, total fees (which are
affected by non-audit fees as well) increase in the year of the going-private transaction, due mainly to

22

These results, however, may appear inconsistent with the findings of Venkataraman et al. [2008], who document that the
audit fees in the two years prior to the IPO are higher than the fees in the year of IPO. While Venkataraman et al. [2008]
focus on pure private firms that go public through an IPO without prior SEC filings; private firms in our sample already
submitted audited financial reports with the SEC prior to the IPO. Therefore, we can expect lower auditor effort and exposure
to litigation risk in our setting where private firms previously submitted audited SEC filings.

22

increases in tax-related fees, and then decrease in the first year after the going-private transaction. These
results are consistent with the decline in audit fees during the private ownership phase and with an
increased demand for non-audit services during the going-private transactions.
Analogous to Panel A, Panel B presents the results for a matched sample of public firms that do
not transition to private equity ownership. The average percentage change in audit fees from year t-1 to
t+1 for the transition sample is -26.1%, while the average change in audit fees for the non-transition
matched sample is 9.7%. The difference in percentage change is -35.8%, which is statistically significant
at the 1% level. Taken together, the patterns of audit fees exhibited in Figure 2 are consistent with an
increase in litigation risk during the public phase, with systematically increasing audit fees charged by
audit firms.23
Estimation results for firms that transition between private and public equity
Table 5, Panel A, reports descriptive statistics for our sample of public debt firms that transition
from private to public equity ownership. The mean and median amounts of AUDIT and AUDIT_S are
statistically smaller for the private firm-years as compared to public firm-years. In addition, private firmyears exhibit significant lower amounts of asset growth, assets, class action lawsuits, submission
according to section 404(b), and the presence of an internal control weakness (ASSET_GR, ASSET,
POST_LS, SOX404, and M_WEAK) as compared to public-firm-years. Furthermore, loss and leverage
(LOSS and LEV) are significantly higher for private firm-years.
[PLACE TABLE 5 HERE]
Consistent with the results in Tables 2 through 4, the results in Table 5, Panel B also indicate
that public years exhibit higher audit fees than private years of the same firms, after controlling for
important client firm and audit firm characteristics. The coefficient on PUBLIC is 0.628 and significant

23

To ensure that the results in Figure 2 are not driven by outliers or size we redid Figure 2 using audit fees scaled by assets
(AUDIT_S). These alternative figures look very similar to the ones presented here and for brevity are not reported.

23

(t-statistic = 4.12), consistent with higher audit fees due to the higher litigation risk. The log
transformation of the coefficient on PUBLIC represents an 87% premium relative to fees charged to
private firms, once the firm goes public. Similarly, total fees (TOTAL) remain significantly higher for
public years and represent a 50% premium relative to total fees for public firms. In contrast to the results
presented in Tables 2 through 4 that utilized a much larger sample, only a few control variables remain
significant with multinational firms (MNC) and size (ASSETS) being two of the largest drivers of audit
fees.
Table 6, Panel A, reports descriptive statistics for our sample of public debt firms that transition
from public to private equity ownership. Overall, the results are qualitative similar to those reported in
Panels A of Tables 2 and 5. While the difference between the audit fees for public and private years is
not as large relative to the full sample results in Table 2, both the mean and median fees are statistically
lower for the private firm-years. In addition, the mean and median amounts of AUDIT_S as well as the
mean of TOTAL_S are significantly higher for public firms relative to private firms.
[PLACE TABLE 6 HERE]
The regression results in Table 6, Panel B, indicate that public years exhibit higher audit fees
than private years of the same firms, after controlling for important client firm and audit firm
characteristics. The coefficient on PUBLIC is 0.388 and significant (t-statistic = 1.81), consistent with
significantly higher audit fees due to the higher litigation risk. The log transformation of the coefficient
on PUBLIC represents a 47% premium relative to fees charged to private firms. Similarly, total fees
remain significantly higher for public years with an estimated premium of 34%. Taken together, the
results in Tables 2 through 6 and Figure 2 consistently suggest that public equity firms, which are likely

24

subject to greater litigation risk, pay significantly larger audit fees after controlling for additional
complexity and other client and audit firm characteristics.24
4.4 Robustness Tests
To mitigate concerns about endogeneity or self-selection of ownership structure, our first
robustness test includes a control variable, the inverse Mills ratio (INV_MILLS) from the first stage of
the Heckman [1979] sample selection correction procedure, to correct for possible self-selection
associated with the decision for a firm to have publicly-traded equity. In the first stage, we estimate the
following probit regression, which predicts whether firm-year observations have publicly-traded equity:
PUBLICj,t = 0 + 1FIRM_AGEj,t + 2INVRECj,t + 3ASSETS_GRj,t + 4BIGAUDj,t
+ 5SEGj,t + 6MNCj,t + 7LITj,t+ 8LOSSj,t + 9LEVj,t + 10ASSETSj,t
+ 11ABNACCj,t + 12POST_LSj,t + 13AUD_TOj,t + 14WORDCTj,t
+ 15SOX404j,t + 16M_WEAKj,t + 17GW_IMPi,t + 18DISCON_OPi,t
ttYEARt + kkINDUSjj,t

where equation (2) is based on models of public and private ownership as in Ball and Shivakumar [2005]
and Givoly et al. [2010]. FIRM_AGE, which is our exclusion restriction variable, is measured as the
number of years since the firms first appearance on Compustat.25 We compute INV_MILLS for each
firm-year observation based on the estimated coefficients for equation (2), and then include that variable
in equation (1), the second stage of the Heckman estimation procedure.26

24

Following Katz [2009], we expect that other organizational changes such as mergers and acquisitions and bankruptcy
might also affect auditor effort and litigation risk, and hence, audit fees charges. To verify that major organizational changes
do not substantially influence our results, we remove observations during the three years surrounding (one year before and
after) each of these transactions. All results remain qualitatively similar.
25
FIRM_AGE is the exclusion restriction variable suggested by Givoly et al. [2010], which does not appear in the second
stage regression. Untabulated results indicated that FIRM_AGE has no significant impact on audit fees in the second-stage
equation (1) while it is an important determinant of public equity selection in the first stage equation (2), as indicated in
Table 7, Panel A. See Lennox et al. [2012] for further discussion on the implementation of the Heckman [1979] two-stage
procedure. Results are qualitatively similar when conducting the first stage regression without FIRM_AGE exclusion
restriction.
26
Stolzenberg and Relles [1997] argue that if selection bias is moderate then the two-step estimation approach can make
estimates worse.

25

As indicated in Table 7, Panel A, FIRM_AGE is positive and significant in the first stage regression,
indicating it is an important determinant of public equity selection. Panel A also indicates we obtain a 63 percent
MacKelvey-Zavonia pseudo-R-squared in the first-stage probit regression, which validates the relevance of our
chosen control variables. Table 7, Panel B, indicates that our primary inferences for audit and total remain
unchanged once we include the inverse mills (INV_MILLS) in the second stage regression. Moreover, the VIF
on the inverse mills is relatively low indicating multicollinearty likely has a limited impact on our results.

[PLACE TABLE 7 HERE]

In our second robustness test, we estimated the effect of SOX404 in each of our regressions. As
to the effect of SOX 404(b) audits on audit fees, we note that although private firms are not subjected to
SOX 404(b), 11 percent of private firms in our sample (25 out of 229) voluntarily engaged their audit
firm to conduct SOX 404(b)-based internal control audits. This frequency is significantly lower than
those of public firms in which the vast majority complied with section 404(b) of SOX. To further
mitigate concerns regarding the effect of section 404(b), we compare (1) public firms to private firms
that both apply section 404(b) of SOX, as well as (2) public to private firms that do not apply section
404(b) of SOX. All results remain qualitatively similar. In addition, separation of the non-transition
sample into two subsamples of before and after SOX leads to similar results to those reported in the
paper.
Our third robustness test considers the role of audit demand-related factors. Although the issue
of audit demand-related factors (public equity shareholders demand and management provides a more
precise and potentially more expensive audit) versus audit supply-related factors (higher expected
litigation costs for public equity firms) is difficult to disentangle because higher litigation risk associated
with public equity is intrinsically linked to the public equity holders, we also attempt to address this
concern by (1) controlling for the presence of voluntary disclosure and (2) including a proxy for
ownership dispersion.
26

After a firm has publicly-traded equity, it likely has a more disperse ownership structure that
could result in shareholders of public firms demanding and public firms providing a more precise and/or
more expensive audit. For instance, Ball et al [2012] suggest that firms allocating more resources to
voluntary disclosure are likely to allocate more resources to audited financial statements. They suggest
the reason firms allocate more resources to the audited information is that the commitment to
independent verification allows managers to credibly disclose private information that is costly for
investors to verify. In our setting, we have some evidence that public equity firms do provide more
voluntary disclosures (e.g., management forecasts). However voluntary disclosure, which is distinct
from the financial reporting requirements, typically is associated with litigation against the auditor and
not the manager, and therefore unlikely to have a substantial effect on audit fees. Indeed, further analysis
reveals that none of our private equity firms provide management forecasts of earnings (First Call), as
compared to 43% of our public equity firms. Moreover, after we control for the presence of management
forecasts, our regressions results remain qualitatively similar with the coefficient on management
forecasts being insignificant (untabulated).
We also attempt to address the audit demand-related factors versus audit supply by including a
proxy for ownership dispersion. Specifically, for the non-transition public firms, we collect aggregate
ownership by all institutional holders with more than five percent of the outstanding stocks (ThomsonReuters Institutional Holdings (13F) Database) as well ownership by the top five executive officers
when available (Execucomp). For all the private firms in our sample as well as the public phase of the
transition firms, we hand-collect ownership data from the SEC filings on all beneficial owners of more
than five percent of the outstanding stocks and all named executive officers as a group.27

27

In particular, for each non-transition private firm we hand collect stock ownership data for only one firm-year and assume
stock ownership remains relatively constant. For the transition sample, we collect stock ownership data in the year prior and
the year after the firm transitions and then assume the stock ownership remains relatively similar to the year we collected.

27

For the non-transition firms, our univariate results indicate the average ownership for private
firms is 82% while the average ownership for public firms is 25%. A higher value for ownership
indicates a more concentrated ownership base. As expected, our univariate results indicate that public
firms have a more disperse ownership structure relative to private firms. However, when we include our
proxy for ownership in Table 3 our results remain very similar to those presented (coefficient on
PUBLIC is 0.124; t-statistic = 3.29) despite the coefficient on our proxy for ownership being positive
and significant (0.084; t-statistic = 1.98). These results suggest that public equity increases audit fees
even after including a proxy for ownership dispersion. Finally, although our results for the transition
sample are weaker than those presented in Tables 5 and 6, the conclusion that public equity increases
audit fees remains qualitatively similar after including our proxy for ownership dispersion.
In our fourth robustness test, we consider audit firm changes as a driver of fee results. Eighteen
of our private transition firms (27%) changed auditors during our sample period. Of those, 13 changed
from a Big 4 to another Big 4, two changed from non-Big 4 to another non-Big 4 and three changed
from Big 4 to non-Big 4. As a robustness check we remove these 18 firms from our analysis and obtain
qualitatively similar results to those presented. For the non-transition sample we have 615 auditor
turnovers, with 77% switching from Big 4 to another Big 4 and 23% switching from either non-Big 4 to
Big 4 or vice versa. As a robustness check, we removed the 615 firm from our analysis and our results
are qualitatively similar to those presented.
Finally, the prior literature introduces several analytical audit pricing models that suggest initial
audit engagements are discounted or that the new auditor lowballs the incumbent auditors fees. Due
to transaction costs (switching and startup costs), such lowballing allows audit firms to realize higher
fees and profits in subsequent years (DeAngelo [1981a]; Dye [1991]). Several studies document that
such discounts existed in the U.S. before (Simon and Francis [1988]; Ettredge and Greenberg [1990])

28

and after (Sankaraguruswamy and Whisenant [2009]) the public disclosure of audit fees. Hence, we
conduct our analyses separately on firms that go private, as well as private firms that remain private,
where such lowballing discount is not predicted. While the higher audit fees of firms that go public
might be attributed to lowballing (e.g. DeAngelo [1981a], Dye [1991], and Sankaraguruswamy and
Whisenant [2009]), our finding of a decrease in audit fees when firms are going private runs opposite to
the lowballing explanation.
5. CONCLUSION
This study investigates how public equity ownership affects audit fees by comparing public and
private U.S. firms. In particular, we examine whether audit fees are higher for public firms relative to
private firms. Our results indicate that when firms have private equity they pay significantly lower audit
fees than when they have publicly-traded equity. These results are consistent with auditors of public
firms charging higher audit fees likely due to higher litigation risk arising from public equity ownership,
despite similar required audit effort under SEC regulations and audit industry practices.
This paper also demonstrates distinctive inter-temporal trends in audit firm fees around goingprivate and going-public transactions. We document a substantial decrease in audit fees around
going-private transactions. This trend continues while firms are privately-held. The trend in audit fees
around going-public transactions is the approximate inverse to that for going-private transactions. Taken
together, our results provide consistent cross-sectional and inter-temporal evidence that audit litigation
risk affects the amount of fees charged by audit firms. Further, the magnitude of the differences we
observe are consistent with ownership structure playing an important role in the pricing of audit fees.
Specifically, we show that audit fees are 12% to 25% higher for public firms relative to private firms.
To our knowledge, this is the first U.S. study to compare the audit fees of firms with different
ownership structures and to document the magnitude of the audit fee premium for public equity firms.

29

Our study should be of interest to auditors, regulators, insurance companies, and investors who are
interested in the likely role that litigation risk plays in the pricing of audits, and to researchers who are
interested in the impact of ownership structure on audit fee pricing. In addition, our investigation into
the audit pricing of public and private firms should be of interest to the Center for Audit Quality as
further evidence of the link between ownership structure and audit fees.

30

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36

APPENDIX
Variable Definitions
Measures of Audit Fees:
AUDIT

= Firm is audit fees (Audit Analytics AUDIT_FEES) which consists of all fees necessary
to perform the audit or review in accordance with Generally Accepted Auditing
Standards. This category also may include services that generally only the
independent accountant reasonably can provide, such as comfort letters, statutory
audits, attest services, consents, and assistance with and review of documents filed
with the SEC.

TOTAL

= Firm is total fees (Audit Analytics TOTAL_FEES) which is the sum of audit fees and
total non-audit fees. Non-audit fees is the sum of audit-related fees, IT fees, tax fees,
and other fees. Audit-related fees are assurance and related services that traditionally
are performed by the independent accountant and include, employee benefit plan
audits, due diligence related to mergers and acquisitions, accounting consultations and
audits in connection with acquisitions, internal control reviews, attest services that are
not required by statute or regulation and consultation concerning financial accounting
and reporting standards. IT fees include financial information systems design and
implementation related fees. Tax fees include fees for tax compliance, tax planning,
and tax advice. Other fees include all other auditor fees.

AUDIT_S

= Firm is audit fees (Audit Analytics AUDIT_FEES) converted into millions of dollars
and divided by total assets (Compustat AT).

TOTAL_S

= Firm is total fees (Audit Analytics TOTAL_FEES) converted into millions of dollars
and divided by total assets (AT).

Public Firm Indicator Variables:

PUBLIC
= 1 when the firm has publicly-traded equity and publicly-traded debt and 0 otherwise.
Control Variables and Other Variables of Interest:
ABNACC
= Firm is abnormal total accruals in year t derived from the modified cross-sectional
Jones [1991] model. To estimate the model yearly by two-digit SIC code, we require that
at least 10 observations be available. The regression model is: TACCj,t / TAj, t1 = a1*[1 /
TAj, t1] + a2*[(REVj, t TRj, t)/TAj, t1] + a3*[PPEj, t / TAj, t1] where: TACC is total
accruals for firm j in year t, which is defined as income before extraordinary items (IBC)
minus net cash flow from operating activities, adjusted to extraordinary items and
discontinued operations (OANCF - XIDOC). TA is the beginning-of-the-year total assets
(lagged AT). REV is the change in sales in year t (SALE), PPE is gross property, plant,
and equipment in year t (PPEGT), and TR is the change in trade receivables in year t
(RECTR). To control for the asymmetric recognition of gains and losses, the modified
Jones model is augmented with the following independent variables: cash flow from
operations in year t (CFt), a dummy variable set to 1 if CFt <1 and 0 otherwise (DCFt),
and an interactive variable, CFt DCFt (as suggested by Ball and Shivakumar [2006]).
CFt is defined as cash from operations in year t adjusted for extraordinary items and
discontinued operations (OANCF - XIDOC).
ASSETS

= Natural logarithm of the total assets (AT) for firm i, at the end of year t.

ASSET_GR

= Firm is total assets growth, where total assets growth is total assets (AT) at the end of
year t minus total assets at the beginning of year t divided by total assets at the
beginning of year t.

AUD_TO

= 1 if the firm changed auditors in year t and 0 otherwise.

BONDRATE

= The S&P Domestic Long Term Issuer Credit Rating (SPLTICRM) at the end of the
fiscal year converted into numerical form. For instance, if a firm has a AAA credit

37

rating this would be coded as 1. If a firm has a AA+ credit rating this would be
coded as a 2. The final credit rating of a D would be coded as a 21. The higher the
BONDRATE the lower the credit quality.
BIGAUD

= 1 if a Big 4 audit firm, and zero otherwise (AU).

CI_ADJ

= Sum of the absolute values of comprehensive income adjustments due to foreign

currency translation adjustments (CICURR), securities gains and losses (CIECGL),
derivative gains and losses (CIDERGL), minimum pension adjustments (CIPEN), and
other (CIOTHER), divided by total assets.

DISCON

= Absolute value of discontinued operations (DO), divided by total assets.

M_WEAK

= 1 if the audit firms report indicates the firm has ineffective internal controls in year t
and 0 otherwise.

FIRM_AGE

= Number of years since the firms first appearance on Compustat.

FIRSTYEAR_PRV

= 1 if the firm-year is the first year the firm is private for firms that transition from public
to private, and zero otherwise.

GW_IMP

= Absolute value of impairments of goodwill (GDWLIA), divided by total assets.

INVREC

= Firm is inventory (INVT) and receivables (RECT), divided by total assets.

LIT

= 1 if SIC is 28332836, 35703577, 36003674, 52005961, or 73707374

(biotechnology, computers, electronics or retailing); and zero otherwise (Francis et al.
1994).

LEV

= Firm is leverage in year t, measured as total debt (DLTT + DLC) divided by total
assets.

LOSS

= 1 if firm i reports a loss, where loss is net income before extraordinary items (IBC) and
zero otherwise.

MNC

= 1 if firms foreign pre-tax income (PIFO) or foreign income taxes (TXFO) is positive or
negative and zero otherwise.

POST_LS

= 1 if the firm-year is after the firm was involved in a class action lawsuit according to
the Stanford class action clearinghouse database and zero otherwise.

SEG

= Number of business segments (BUSSEG).

SOX404

=1 if according to Audit Analytics the firms auditor applied the requirements of section
404(b) of the Sarbanes-Oxley Act and zero otherwise.

YEAR_IPO

= 1 if the firm-year is the first year the firm is public for firms that transition from private
to public, and zero otherwise.

WORDCT

= The number of words, in thousands, in the 10-K.

jFIRMi

= 1 for firm i and zero otherwise.

jINDUSi

= 1 if firm i is in industry j in year t, based on three-digit SIC codes, and zero otherwise.

jYEARi

= 1 if firm i is in year j, and zero otherwise.

All continuous variables are winsorized at the 1st and 99th percentiles

38

TABLE 1
Sample Selection
Sample Selection Procedures for Private Firms with Public Debt (20002009)

Potential private firms with public debt (Compustat)a

Eliminate firms that:
Do not have historical (non-prospectus) datab
Are public firms
Are subsidiaries of public firms
Are involved in bankruptcy proceedings
Are foreign firms or subsidiaries of foreign firms
Otherc
Subtotal of private firms with public debt
Eliminate firms that:
Are cooperatives, LPs, or government-owned
Subtotal of private firms with public debt
Eliminate firms that:
Are missing required Compustat data
Are missing Audit Analytics datad
Total Sample of private firms with public debt
Sample of steady-state (non-transition) private firms with public
debte
Sample of steady-state (non-transition) private firms with public
debt-propensity score matchedf
Sample of private firms that transition from private to publicg
Sample of private firms that transition from public to privateh
a The

No. of Firm-Years
3,390

No. of Firms
1,072

(1,327)
(113)
(92)
(56)
(218)
(127)
1,457

(576)
(26)
(22)
(16)
(81)
(15)
336

(78)
1,379

(13)
323

(83)
(524)
772

(12)
(82)
229

628

162

427

112

90
54

44
23

sample of potential private firms with public debt consists of all firm-year observations on Compustat in any year from 20002009
that satisfy the following criteria: (1) the firms stock price at fiscal year-end is unavailable; (2) the firm has total debt as well as total
revenues exceeding $1 million; (3) the firm is a domestic company; (4) the firm is not a subsidiary of another public firm; and (5) the
firm is not a financial institution or in a regulated industry (SIC codes 60006999 and 48004900).
b Compustat reports three years of historical information for public firms that file for initial public offering. This financial information is
taken from the prospectus.
c Other includes observations of the same firm with different names, firms that have joint ventures and partnerships with public firms,
firms that are public spin-offs, and holding companies of public firms.
d We hand-collected audit data information only for those private firms that are missing information on Audit Analytics and have both
private firms-years and public firm-years.
e The corresponding sample of public equity firms with public debt has 11,322 firm-years and 1,950 firms.
f The propensity score matched procedure results in 427 firm-years and 147 firms with public equity and public debt.
g The 44 transition firms that move from private to public equity ownership have 90 private and 144 public firm-years.
h The 23 transition firms that move from public to private equity ownership have 54 private and 104 public firm-years.

39

TABLE 2
Descriptive Statistics and Correlations for Steady-State Firms
Panel A: Descriptive Statistics for Firm Characteristics for Steady-State (Non-Transition) Firms
Private Firm-Years
Variable

Public Firm-Years

Difference

q1

mean

median

q3

std.dev.

q1

mean

median

q3

std.dev.

mean

AUDIT

288,000

864,828

502,875

912,699

1,176,635

573,600

2,836,456

1,348,000

2,996,910

5,122,151

-1,971,628

***

median

TOTAL

460,875

1,304,277

771,433

1,353,780

1,898,167

928,000

4,231,732

1,943,000

4,347,000

7,761,006

-2,927,455

***

AUDIT_S

0.00028

0.00117

0.00074

0.00147

0.00142

0.00039

0.00133

0.00080

0.00156

0.00196

-0.00016

**

-0.00006

TOTAL_S

0.00085

0.00204

0.00161

0.00251

0.00189

0.00064

0.00184

0.00123

0.00224

0.00238

0.00019

0.00038

INVREC

0.12

0.27

0.26

0.38

0.18

0.13

0.26

0.24

0.35

0.17

0.01

0.02

ASSET_GR

-0.02

0.02

0.00

0.05

0.17

-0.03

0.02

0.01

0.10

0.19

0.00

BIGAUD

1.00

0.91

1.00

1.00

0.29

1.00

0.93

1.00

1.00

0.25

-0.02

**

0.00

SEG

1.00

1.96

1.00

3.00

1.34

1.00

2.33

2.00

3.00

1.57

-0.38

***

-1.00

***

MNC

0.00

0.47

0.00

1.00

0.50

0.00

0.66

1.00

1.00

0.47

-0.19

***

-1.00

***

LIT

0.00

0.13

0.00

0.00

0.34

0.00

0.21

0.00

0.00

0.41

-0.08

***

0.00

LOSS

0.00

0.45

0.00

1.00

0.50

0.00

0.28

0.00

1.00

0.45

0.16

***

0.00

LEV

0.48

0.70

0.66

0.91

0.34

0.16

0.31

0.27

0.41

0.23

0.39

***

0.39

***

ASSETS

5.51

6.29

6.25

6.98

1.05

6.42

7.42

7.41

8.43

1.58

-1.13

***

-1.16

***

ABNACC

-0.06

-0.02

-0.01

0.02

0.08

-0.03

0.00

0.00

0.04

0.09

-0.02

***

-0.01

**

POST_LS

0.00

0.00

0.00

0.00

0.07

0.00

0.12

0.00

0.00

0.32

-0.11

***

0.00

-845,125

***

-1,171,567 ***

-0.01

AUD_TO

0.00

0.06

0.00

0.00

0.23

0.00

0.05

0.00

0.00

0.22

0.01

WORDCT

27.95

47.05

41.08

50.00

32.40

32.91

54.09

46.37

64.14

32.88

-7.04

***

-5.30

0.00
***

SOX404

0.00

0.04

0.00

0.00

0.18

0.00

0.53

1.00

1.00

0.50

-0.50

***

-1.00

***

***

M_WEAK

0.00

0.00

0.00

0.00

0.00

0.00

0.03

0.00

0.00

0.18

-0.03

GW_IMP

0.0000

0.0045

0.0000

0.0000

0.0271

0.0000

0.0064

0.0000

0.0000

0.0342

-0.0019

DISCON_OP

0.0000

0.0033

0.0000

0.0000

0.0156

0.0000

0.0037

0.0000

0.0000

0.0155

-0.0004

CI_ADJ

0.0000

0.0091

0.0026

0.0102

0.0182

0.0011

0.0159

0.0068

0.0206

0.0242

-0.0068

***

-0.0042

***

BONDRATE

14.00

14.76

15.00

16.00

2.03

9.00

11.07

12.00

14.00

3.57

3.69

***

3.00

***

Firm-Years

628

0.00
0.0000
0.0000

11,322

*,**,***

indicates significance between the private and public firm-years at the 10%, 5%, and 1% level, respectively. Differences between means (medians) are
tested for significance using a two-tailed t-test (two-tailed Wilcoxon signed rank test). CI_ADJ has 407 private and 6,952 public firm-year observations.
BONDRATE has 477 private and 8,386 public firm-year observations. All variables are as defined in the Appendix.

40

Panel B: Pearson (top) and Spearman (bottom) Correlations for Steady-State Firms
1
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24

PUBLIC
AUDIT
TOTAL
AUDIT_S
TOTAL_S
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
CI_ADJ
BONDRATE

0.173
0.177
0.027
-0.058
-0.012
0.032
0.021
0.051
0.090
0.044
-0.081
-0.265
0.176
0.067
0.080
-0.006
0.066
0.222
0.042
0.013
0.042
0.097
-0.264

2
0.088
0.936
0.045
-0.080
0.023
0.108
0.236
0.243
0.418
0.004
-0.156
-0.178
0.741
0.004
0.205
-0.102
0.323
0.534
0.123
0.123
0.199
0.441
-0.428

3
0.086
0.894

4
5
0.019 -0.018
0.000 -0.040
-0.055 -0.042
-0.082
0.935
-0.068 0.896
0.027 0.237 0.256
0.095 -0.148 -0.182
0.270 -0.192 -0.167
0.256 -0.017 -0.017
0.448 0.067 0.081
0.021 -0.012
0.009
-0.162 0.192 0.212
-0.190 -0.006
0.009
0.782 -0.592 -0.634
0.021 -0.104 -0.094
0.179 0.054
0.019
-0.113 -0.017 -0.034
0.301 -0.010 -0.062
0.360 0.266
0.036
0.093 0.172 0.143
0.104 0.084 0.058
0.183 0.106 0.087
0.432
0.009 -0.010
-0.492 0.404 0.394

6
7
-0.016
0.000
0.016 0.019
0.010
0.017
0.128 -0.180
0.144 -0.198
-0.025
-0.008
-0.069 0.052
0.147
0.023
0.135 0.050
-0.021 -0.017
-0.094 -0.404
-0.251 0.095
-0.127 0.188
0.054 0.179
-0.046 -0.029
0.016 -0.018
-0.195
0.000
-0.056 0.118
0.011 -0.019
0.037 -0.255
-0.004 -0.136
0.128 -0.083
-0.079 -0.243

8
0.021
0.109
0.113
-0.189
-0.173
-0.075
0.033
0.067
0.106
0.004
-0.093
0.008
0.289
0.022
0.010
-0.133
0.080
0.060
-0.024
-0.005
0.016
0.137
-0.156

9
0.054
0.263
0.280
-0.069
-0.071
0.092
0.021
0.070
0.155
-0.158
-0.116
-0.120
0.203
0.047
0.005
-0.006
0.038
0.032
0.009
0.019
0.124
0.159
-0.251

10
11
0.090 0.044
0.225
0.013
0.230 0.029
0.003 0.034
0.011 0.048
0.074 -0.027
0.032 -0.035
0.106
0.004
0.165 -0.148
-0.031
-0.031
-0.077 0.039
-0.196 -0.097
0.278
0.010
0.009
0.018
0.059 0.109
-0.037 -0.011
0.076
0.010
0.121
0.004
0.039
0.011
0.059
0.005
0.049 -0.021
0.429 -0.092
-0.272 -0.011

12
-0.081
-0.089
-0.089
0.191
0.202
-0.083
-0.356
-0.093
-0.121
-0.077
0.039
0.123
-0.256
-0.372
0.035
0.050
0.091
-0.103
0.065
0.285
0.045
-0.053
0.448

13
-0.347
-0.138
-0.140
0.023
0.042
-0.216
0.199
-0.010
-0.134
-0.199
-0.074
0.149

-0.160
-0.057 0.083
-0.065 0.118
0.019 -0.074
0.052 0.261
-0.088 0.243
0.001 -0.024
-0.039 0.036
-0.032 0.086
-0.149 0.302
0.451 -0.659

Bold denotes significantly different from zero at the 5 percent levels or greater (two-tailed).

41

14
0.161
0.534
0.547
-0.447
-0.487
-0.150
0.171
0.328
0.241
0.283
0.015
-0.251
-0.178

15
16
0.046 0.080
0.013 0.215
0.026 0.198
-0.108 0.067
-0.100
0.041
0.053 -0.049
0.235 -0.050
0.023
0.010
0.049
0.012
0.003 0.059
-0.008 0.109
-0.382
0.035
-0.048 -0.056
0.068 0.135
-0.044
-0.025
-0.026 -0.016
-0.084 0.128
-0.003 0.185
-0.081 0.065
-0.216 0.054
-0.027 0.051
0.044 0.048
-0.243 -0.042

17
18
-0.006 0.048
-0.049 0.174
-0.051
0.141
0.017
0.011
0.004 -0.003
0.018 -0.138
-0.030 -0.016
-0.133 0.063
-0.007 0.041
-0.037 0.051
-0.011
0.002
0.050 0.089
0.019
0.042
-0.074 0.211
-0.024 -0.064
-0.016 0.088
0.004
-0.007
-0.067 0.193
0.039 0.087
0.008 0.075
0.011 0.112
-0.015 0.142
0.059 0.042

19
20
0.222 0.042
0.266 0.146
0.134 0.096
0.129 0.204
0.010 0.168
-0.061
0.006
0.072 -0.013
0.060 -0.024
0.035
0.004
0.121 0.039
0.004
0.011
-0.103 0.065
-0.089 -0.004
0.251 -0.017
-0.007 -0.068
0.185 0.065
-0.067
0.039
0.107 0.075
0.174
0.174
0.093 0.046
0.117 0.069
0.257
0.005
-0.071 0.099

21
22
0.013
0.005
0.002
0.010
-0.008
0.030
0.115 0.095
0.108 0.119
0.022 -0.012
-0.393 -0.196
-0.014 -0.036
-0.020
0.013
0.032
0.006
0.035
0.013
0.267 0.105
-0.044 -0.025
-0.044 -0.050
-0.379 -0.030
0.056 0.037
0.014
0.018
0.028 0.045
0.060 -0.006
0.014 0.031
0.059
0.085
0.093 0.100
0.107
0.014

23
0.065
0.186
0.182
-0.012
-0.013
0.050
-0.150
0.070
0.120
0.227
-0.095
0.012
-0.126
0.191
0.024
0.020
0.001
0.118
0.134
-0.010
0.092
0.057
-0.211

24
-0.231
-0.326
-0.375
0.354
0.344
-0.033
-0.204
-0.144
-0.272
-0.265
-0.032
0.434
0.398
-0.653
-0.237
-0.057
0.060
0.067
-0.067
0.096
0.134
0.071
-0.111

TABLE 3
Results for Regressions of Audit and Total Audit Fees on a Public Firm-Year Indicator Variable
and Other Control Variables Based on a Sample of Steady-State Public and Private Firms
AUDIT

TOTAL

Coeff

t-stat

Coeff

t-stat

Intercept

8.590

166.779

***

8.981

174.901

***

PUBLIC

0.116

INVREC

0.635

4.251

***

0.139

5.248

***

15.968

***

0.606

15.367

***

ASSET_GR

-0.407

-10.661

***

-0.352

-9.888

***

BIGAUD

0.171

6.950

***

0.239

9.808

***

SEG

0.069

17.473

***

0.071

17.786

***

MNC

0.477

34.944

***

0.526

39.027

***

LIT

0.021

1.365

0.082

1.551

LOSS

0.084

5.330

**

0.072

4.710

***

LEV

0.149

5.317

***

0.167

6.075

***

ASSETS

0.524

110.713

***

0.550

114.109

***

ABNACC

-0.132

-1.712

**

-0.153

-2.044

**

POST_LS

0.241

13.139

***

0.213

11.820

***

AUD_TO

-0.280

-7.398

***

-0.353

-9.879

***

WORDCT

0.002

11.079

***

0.002

10.411

***

SOX404

0.404

27.898

***

0.138

10.072

***

M_WEAK

0.095

9.719

***

0.100

10.655

***

GW_IMP

0.650

3.464

***

0.478

2.760

***

DISCON_OP

2.627

6.710

***

4.113

10.527

***

Adjusted R
N

0.7567
11,950

0.7476
11,950

*,**,***

indicates significance at the 10%, 5%, and 1% level using a two-tailed t-test, respectively. In the first two columns the
dependent variable is the natural logarithm of AUDIT and TOTAL fees. Regressions include industry and year indicator
variables, which have not been tabulated. The t-statistics have been adjusted to control for the clustering by multiple firm
observations. All variables are as defined in the Appendix.

42

TABLE 4
Descriptive Statistics and Regressions for the Propensity Matched Steady-State Sample
Panel A: Descriptive Statistics for the Propensity Matched Steady-State Sample

Variable
AUDIT
TOTAL
AUDIT_S
TOTAL_S
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
Firm-Years

q1
318,000
516,000
0.00049
0.00072
0.09
-0.02
1.00
1.00
0.00
0.00
0.00
0.42
5.78
-0.05
0.00
0.00
27.63
0.00
0.00
0.0000
0.0000

Private
mean
957,102
1,395,501
0.00123
0.00181
0.26
0.01
0.92
1.93
0.49
0.16
0.39
0.56
6.54
-0.01
0.00
0.05
48.83
0.05
0.00
0.0049
0.0026

Firm-Years
median
q3
601,332 1,003,070
890,322 1,602,220
0.00090
0.00150
0.00135
0.00220
0.24
0.37
0.00
0.04
1.00
1.00
1.00
3.00
0.00
1.00
0.00
0.00
0.00
1.00
0.57
0.71
6.55
7.24
0.00
0.02
0.00
0.00
0.00
0.00
39.83
58.49
0.00
0.00
0.00
0.00
0.0000
0.0000
0.0000
0.0000
427

std.dev.
1,246,727
1,721,568
0.00147
0.00189
0.19
0.15
0.27
1.32
0.50
0.36
0.49
0.26
0.96
0.07
0.07
0.23
34.03
0.22
0.00
0.0294
0.0140

q1
418,675
642,600
0.00073
0.00105
0.11
-0.05
1.00
1.00
0.00
0.00
0.00
0.29
5.64
-0.03
0.00
0.00
30.87
0.00
0.00
0.0000
0.0000

*,**,***

Public Firms-Years
mean
median
q3
1,514,429 947,029 1,716,620
1,942,952 1,308,000 2,298,460
0.00204 0.00126 0.00235
0.00259 0.00167 0.00307
0.27
0.24
0.39
0.00
0.00
0.09
0.84
1.00
1.00
2.03
1.00
3.00
0.48
0.00
1.00
0.16
0.00
0.00
0.35
0.00
1.00
0.48
0.43
0.63
6.44
6.54
7.43
-0.01
0.00
0.04
0.07
0.00
0.00
0.09
0.00
0.00
50.95
43.55
57.33
0.49
0.00
1.00
0.07
0.00
0.00
0.0106
0.0000
0.0000
0.0054
0.0000
0.0001
427

std.dev.
2,661,646
2,922,210
0.00261
0.00302
0.18
0.23
0.37
1.42
0.50
0.36
0.48
0.28
1.34
0.10
0.26
0.29
32.85
0.50
0.25
0.0534
0.0198

mean
-557,327
-547,451
-0.00081
-0.00078
-0.01
0.00
0.09
-0.10
0.00
0.00
0.04
0.09
0.10
0.00
-0.07
-0.04
-2.11
-0.44
-0.07
-0.0057
-0.0028

Difference
median
*** -345,697
*** -417,678
*** -0.00035
*** -0.00032
0.00
0.00
**
0.00
0.00
0.00
0.00
0.00
***
0.13
0.01
-0.01
***
0.00
**
0.00
-3.73
***
0.00
***
0.00
*
0.0000
0.0000

***
***
***
***

***

indicates significance between the private and public firm-years at the 10%, 5%, and 1% level, respectively. Differences between means (medians) are tested
for significance using a two-tailed t-test (two-tailed Wilcoxon signed rank test). The propensity matching is based on the same fiscal year, industry (3-digit SIC code),
and closest propensity score match, where propensity score match is based on leverage, abnormal accruals, sales, assets, and foreign operations. All variables are as
defined in the Appendix.

43

Panel B. Regressions for the Propensity Matched Steady-State Sample

Intercept
PUBLIC
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
Adjusted R2
N

Coeff
8.642
0.220
0.618
-0.635
0.139
0.052
0.388
-0.219
0.092
0.361
0.524
0.018
0.482
-0.081
0.004
0.677
-0.088
2.184
0.174

AUDIT
t-stat
50.642
4.667
4.324
-3.886
2.019
2.947
7.972
-3.694
1.610
3.695
24.600
0.068
4.283
-0.814
4.959
5.952
-0.162
1.607
2.529
0.7323
854

*,**,***

***
***
***
***
**
***
***
***
***
***
***
***
***

**

Coeff
8.919
0.171
0.587
-0.507
0.204
0.052
0.434
-0.198
0.095
0.392
0.555
-0.002
0.399
-0.140
0.003
0.616
0.201
3.760
0.107

TOTAL
t-stat
51.738
3.616
3.978
-3.253
2.882
2.962
9.189
-3.390
1.659
3.978
26.000
-0.006
3.821
-1.331
3.929
5.242
0.380
2.899
1.499
0.7221
854

***
***
***
***
***
***
***
***
*
***
***
***
***
***
***

indicates significance at the 10%, 5%, and 1% level using a two-tailed t-test, respectively. In the first two
columns the dependent variable is the natural logarithm of AUDIT and TOTAL fees. The propensity matching is
based on the same fiscal year, industry (3-digit SIC code), and closest propensity score match, where propensity score
match is based on leverage, abnormal accruals, sales, assets, and foreign operations. Regressions include industry and
year indicator variables, which have not been tabulated. The t-statistics have been adjusted to control for the clustering
by multiple firm observations. All variables are as defined in the Appendix.

44

TABLE 5
Descriptive Statistics and Regression Analysis for Firms that Transition from Private to Public Equity
Panel A: Descriptive Statistics for Firms that Transition from Private to Public Equity

Variable
AUDIT
TOTAL
AUDIT_S
TOTAL_S
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
Firm-Years

q1
272,270
455,000
0.00055
0.00094
0.12
0.00
1.00
1.00
0.00
0.00
0.00
0.50
5.64
-0.06
0.00
0.00
36.77
0.00
0.00
0.0000
0.0000

Private Firm-Years
mean
median
q3
std.dev.
827,928
484,469 691,000 1,683,678
1,843,060 769,997 1,135,000 6,413,077
0.00185
0.00112 0.00184 0.00224
0.00342
0.00187 0.00350 0.00506
0.27
0.22
0.36
0.19
0.05
0.00
0.06
0.16
0.87
1.00
1.00
0.34
2.32
1.00
3.00
1.62
0.57
1.00
1.00
0.50
0.17
0.00
0.00
0.37
0.56
1.00
1.00
0.50
0.71
0.72
0.91
0.32
6.04
6.07
6.87
1.28
-0.02
-0.01
0.02
0.11
0.00
0.00
0.00
0.00
0.04
0.00
0.00
0.21
48.41
46.00
50.00
21.74
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.0040
0.0000
0.0000
0.0208
0.0021
0.0000
0.0000
0.0138
90

q1
720,240
915,783
0.00090
0.00123
0.17
0.00
1.00
1.00
0.00
0.00
0.00
0.25
6.03
-0.06
0.00
0.00
36.06
0.00
0.00
0.0000
0.0000

*,**,***

Public Firm-Years
mean
median
q3
1,633,855 1,074,865 1,810,000
2,378,453 1,308,000 2,291,500
0.00229 0.00182 0.00299
0.00287 0.00236 0.00377
0.27
0.24
0.37
0.10
0.06
0.20
0.89
1.00
1.00
2.13
1.00
3.00
0.65
1.00
1.00
0.18
0.00
0.00
0.24
0.00
0.00
0.52
0.50
0.71
6.50
6.48
7.11
-0.01
-0.01
0.05
0.06
0.00
0.00
0.02
0.00
0.00
49.45
42.80
50.18
0.60
1.00
1.00
0.04
0.00
0.00
0.0098
0.0000
0.0000
0.0022
0.0000
0.0000
144

std.dev.
2,186,309
5,394,853
0.00210
0.00249
0.17
0.20
0.32
1.43
0.48
0.39
0.43
0.36
1.14
0.11
0.24
0.14
25.02
0.49
0.20
0.0432
0.0113

Difference
mean
median
-805,927 *** -590,396
-535,393
-538,004
-0.00044 * -0.00071
0.00056
-0.00049
0.00
-0.02
-0.05
*
-0.06
-0.02
0.00
0.20
0.00
-0.08
0.00
-0.01
0.00
0.32
***
1.00
0.20
***
0.22
-0.46
*** -0.42
-0.01
0.00
-0.06
**
0.00
0.02
0.00
-1.04
3.20
-0.60
*** -1.00
-0.04
*
0.00
-0.0059
0.0000
-0.0001
0.0000

***
**

***
***
***

***

indicates significance between the private and public firm-years at the 10%, 5%, and 1% level, respectively. Differences between means (medians) are
tested for significance using a two-tailed t-test (two-tailed Wilcoxon signed rank test). All variables are as defined in the Appendix.

45

Panel B: Regression Results for firms that Transition from Private to Public Equity

Intercept
PUBLIC
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
YEAR_IPO

Adjusted R2
N

Coeff
9.492
0.628
-0.096
-0.571
-0.058
0.037
0.524
0.156
-0.025
0.282
0.499
0.823
-0.424
0.051
0.001
0.088
0.649
0.853
0.654
-0.093

AUDIT
t-stat
24.471
4.124
-0.314
-2.047
-0.281
1.085
5.483
1.369
-0.292
2.155
8.261
1.853
-1.275
0.193
0.417
0.749
2.075
0.787
0.203
-0.723
0.7368
234

*,**,***

***
***
**

***

**
***
*

**

TOTAL
Coeff
t-stat
9.626
21.286
0.403
2.685
0.184
0.365
-0.266 -0.816
0.196
1.125
0.052
1.563
0.550
5.370
0.123
1.176
-0.002 -0.587
0.344
2.558
0.515
7.662
1.012
2.486
-0.491 -2.082
-0.001
0.311
0.002
0.951
-0.027
0.356
0.602
1.792
1.080
1.096
-3.454 -0.684
-0.026 -0.118
0.7214
234

***
***

***

**
***
**
**

indicates significance at the 10%, 5%, and 1% level using a two-tailed t-test, respectively. The dependent variable
is the natural logarithm of AUDIT and TOTAL fees. Regressions include industry, year, and firm indicator variables,
which have not been tabulated. The t-statistics have been adjusted to control for the clustering by multiple firm
observations. All variables are as defined in the Appendix.

46

TABLE 6
Descriptive Statistics and Regression Analysis for Firms that Transition from Public to Private Equity
Panel A: Descriptive Statistics for Firms that Transition from Public to Private Equity

Variable
AUDIT
TOTAL
AUDIT_S
TOTAL_S
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
Firm-Years

q1
162,300
561,000
0.00027
0.00037
0.06
-0.01
1.00
1.00
0.00
0.00
0.00
0.46
6.34
-0.04
0.00
0.00
36.02
0.00
0.00
0.0000
0.0000

Private Firm-Years
mean
median
q3
std.dev.
2,253,004 845,968 3,709,000 2,722,790
3,782,263 1,697,630 4,841,000 4,613,347
0.00058 0.00052
0.00083 0.00040
0.00098 0.00086
0.00124 0.00079
0.15
0.13
0.23
0.10
0.05
0.02
0.07
0.19
0.96
1.00
1.00
0.19
2.09
1.00
3.00
1.43
0.61
1.00
1.00
0.49
0.37
0.00
1.00
0.49
0.43
0.00
1.00
0.50
0.63
0.52
0.70
0.30
7.56
7.56
8.44
1.40
-0.01
-0.01
0.01
0.05
0.06
0.00
0.00
0.23
0.07
0.00
0.00
0.26
60.39
49.65
65.48
38.36
0.19
0.00
0.00
0.39
0.04
0.00
0.00
0.19
0.0019
0.0000
0.0000
0.0094
0.0031
0.0000
0.0000
0.0154
54

q1
539,032
491,451
0.00030
0.00056
0.10
0.00
1.00
1.00
0.00
0.00
0.00
0.09
5.82
-0.03
0.00
0.00
34.27
0.00
0.00
0.0000
0.0000

*,**,***

Public Firm-Years
mean
median
q3
std.dev.
2,637,865 1,625,000 3,437,240 2,972,588
3,890,239 2,355,750 5,600,000 4,665,165
0.00100 0.00060 0.00107 0.00222
0.00156 0.00092 0.00166 0.00344
0.21
0.18
0.28
0.13
0.12
0.06
0.18
0.17
0.99
1.00
1.00
0.10
2.01
1.00
3.00
1.36
0.60
1.00
1.00
0.49
0.30
0.00
1.00
0.46
0.16
0.00
0.00
0.37
0.35
0.26
0.46
0.34
7.48
7.76
8.56
1.67
0.00
0.00
0.03
0.08
0.08
0.00
0.00
0.27
0.06
0.00
0.00
0.23
53.26
46.00
59.89
33.13
0.22
0.00
0.00
0.42
0.04
0.00
0.00
0.19
0.0018
0.0000
0.0000
0.0109
0.0011
0.0000
0.0000
0.0070
104

Difference
mean
median
-384,861 * -779,033 **
-107,975
-658,120 *
-0.00042 * -0.00008 *
-0.00058 * -0.00005
-0.06 *** -0.05
**
-0.07 **
-0.04
*
-0.03
0.00
0.08
0.00
0.01
0.00
0.07
0.00
0.26 ***
0.00
0.28 ***
0.26
***
0.08
-0.20
-0.01
-0.01
-0.02
0.00
0.02
0.00
7.13
3.65
-0.04
0.00
0.00
0.00
0.0001
0.0000
0.0021 *** 0.0000

indicates significance between the private and public firm-years at the 10%, 5%, and 1% level, respectively. Differences between means (medians) are tested for significance
using a two-tailed t-test (two-tailed Wilcoxon signed rank test). All variables are as defined in the Appendix.

47

Panel B: Regression Results for firms that Transition from Public to Private Equity

Intercept
PUBLIC
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
FIRSTYEAR_PRV

Adjusted R2
N

Coeff
8.402
0.388
0.417
-0.322
0.470
-0.118
0.179
-0.021
0.264
-0.033
0.662
1.534
0.059
0.409
0.000
0.271
0.192
-4.439
4.928
-0.146

AUDIT
t-stat
16.417
1.810
0.770
-0.942
1.210
-3.570
1.663
-0.215
1.568
-0.195
13.377
1.092
0.256
3.273
0.144
2.004
1.112
-1.369
2.300
-1.068
0.8689
158

*,**,***

***
*

***
*

***

***
**

**

TOTAL
Coeff
t-stat
9.265
16.862
0.296
1.693
-0.513 -0.946
-0.514 -1.382
0.499
1.149
-0.062 -1.910
0.265
2.263
-0.115 -1.139
0.145
0.923
0.068
0.376
0.673
13.085
1.688
1.242
0.111
0.546
0.290
1.462
0.001
0.590
0.093
0.706
0.438
2.044
-3.106 -0.925
2.485
0.897
-0.065 -0.479
0.8704
158

***
*

*
**

***

**

indicates significance at the 10%, 5%, and 1% level using a two-tailed t-test, respectively. The dependent
variable is the natural logarithm of AUDIT and TOTAL fees. Regressions include industry, year, and firm indicator
variables, which have not been tabulated. The t-statistics have been adjusted to control for the clustering by multiple
firm observations. All variables are as defined in the Appendix.

48

TABLE 7
Results for the First-Stage and Second-Stage Regression of Heckman Two-Stage Procedure
Panel A: Results for the First-Stage Regression of the Heckman Two-Stage Procedure, where PUBLIC
is the Dichotomous Dependent Variable

Intercept
FIRM_AGE
INVREC
ASSET_GR
BIGAUD
SEG
MNC
LIT
LOSS
LEV
ASSETS
ABNACC
POST_LS
AUD_TO
WORDCT
SOX404
M_WEAK
GW_IMP
DISCON_OP
Fixed Effects Included
MacKelvey_Zavonia Pseudo-R2
McFaddens LRI Pseudo-R2
N

Coefficient Pr > Chi2

2.178
0.000
0.072
0.000
-1.934
0.000
1.254
0.000
-0.372
0.040
-0.062
0.089
0.041
0.687
0.360
0.009
0.087
0.451
-3.861
0.000
0.148
0.001
1.263
0.018
2.941
0.000
-0.029
0.888
0.005
0.004
1.936
0.000
10.308
0.932
4.425
0.023
-5.796
0.155
Industry, Year
0.633
0.182
11,950

Panel B: Summary Results for the Second-Stage Regression of the Heckman Two-Stage Procedure

PUBLIC
INV_MILLS
Adjusted R2
N
VIF (INV_MILLS)

AUDIT
Coeff
t-stat
0.161
2.92
0.019
1.29
0.7563
11,950
5.94

*,**,***

***

TOTAL
Coeff
t-stat
0.131
1.91
0.017
1.38
0.7456
11,950
5.94

**

indicates significance at the 10%, 5%, and 1% level using a two-tailed t-test, respectively. The dependent variable in Panel
B is the natural logarithm of AUDIT and TOTAL fees. Regressions include all additional control variables as in Table 3, including
industry and year indicator variables, which have not been tabulated. The t-statistics have been adjusted to control for the
clustering by multiple firm observations. Multicollinearity is typically regarded as high when the variance-inflation-factor (VIF)
exceeds 10 (Belsey et al. [1980]). All variables are as defined in the Appendix.

49

50

FIGURE 2
Transition Firms and a Matched Sample of Non-Transition Firms
Panel A: Firms Transitioning from Private to Public Equity Ownership and a Matched Sample of Non-Transition Firms

$3,000,000
$2,500,000
$2,000,000
$1,500,000
$1,000,000
$500,000
$0
-2
AUDIT

-1

TOTAL

1
AUDIT_MATCH

2
TOTAL_MATCH

AUDIT_MATCH (TOTAL_MATCH) is the AUDIT_FEES (TOTAL_FEES) for similar public firms that do not transition to private equity ownership. The match is
conducted in year t-1 and the matched firm remains constant throughout the time period. The match is based on the same fiscal year, industry (3-digit SIC code), and
closest propensity score match, where propensity score match is based on leverage, abnormal accruals, sales, assets, and foreign operations. The average percentage change
in audit fees from year t-1 to t+1 for the transition sample is 70.7% while the average change in audit fees from year t-1 to t+1 for the non-transition matched sample is
6.7%. The difference in percentages change (70.7% - 6.7%) is 64.0% which is statistically significant at the 1% level (t-statistic = 5.93). Year 0 represents the year the
firm went public. All variables are as defined in the Appendix

51

Panel B: Firms Transitioning from Public to Private Equity Ownership and a Matched Sample of Non-Transition Firms

$4,500,000

$4,000,000
$3,500,000
$3,000,000
$2,500,000
$2,000,000
$1,500,000
$1,000,000
$500,000
$0
-2
AUDIT

-1

0
TOTAL

1
AUDIT_MATCH

2
TOTAL_MATCH

AUDIT_MATCH (TOTAL_MATCH) is the AUDIT (TOTAL) fee for similar public firms that do not transition to private equity ownership. The match is conducted in
year t-1 and the matched firm remains constant throughout the time period. The match is based on the same fiscal year, industry (3-digit SIC code), and closest propensity
score match, where propensity score match is based on leverage, abnormal accruals, sales, assets, and foreign operations. The average percentage change in audit fees
from year t-1 to t+1 for the transition sample is -26.1% while the average change in audit fees from year t-1 to t+1 for the non-transition matched sample is 9.7%. The
difference in percentages change (-26.1% - 9.7%) is -35.8% which is statistically significant at the 1% level (t-statistic = -3.91). Year 0 represents the year the firm went
private. All variables are as defined in the Appendix

52