An intended purpose of financial accounting information is to reduce information asymmetry by allowing external providers of capital to better assess the firm’s investment opportunities and monitor managerial actions (e.g., Fama and Jensen 1983; Diamond and Verrecchia 1991; Bushman and Smith 2001; Healy and Palepu 2001; Beatty, Liao, and Weber 2008). In other words, financial accounting transparency should ease financing constraints by reducing the adverse selection or moral hazard costs associated with information asymmetry. However, in certain settings, financial accounting may serve a limited role in reducing information costs.
This could occur for a variety of reasons, such as alternative sources of information being available, weak institutional features protecting external providers of capital, close relations between managers and external providers of financing, and lower-quality financial information. We examine the association between the firm’s financial reporting transparency (i.e., firms that subject their financial statements to an external audit) and financing constraints (i.e., more difficult access to external financing and higher financing cost), as well as the mediating role of ownership concentration, for an extensive sample of private firms from 68 countries.
Private firms make up the vast majority of economic activity around the world, yet they have received very limited attention in academic research. Thus, examining the role of accounting information for private firms is economically important in its own right. An interesting feature of a sample of private firms is that these firms have a limited information environment compared with the relatively richer disclosure environment of public firms (e.g., Burgstahler, Hail, and Leuz 2006).
In general, private firms have chosen to remain private because presumably the benefits of be being a public company (e.g., increased access to external financing, lower cost of capital) may not outweigh the costs (e.g., higher reporting costs, increased regulation, greater public scrutiny, reduced managerial discretion). Therefore, these firms may have reasons for being private, and these reasons may reduce or make unnecessary the role of public accounting information in facilitating the relation between external providers of finance and the firm. As discussed in footnote 1, accounting researchers are interested in understanding settings in which the role of accounting information is not obvious. Equally importantly, public firms are generally subject to mandatory audit requirements. Hence, using a sample of private firms makes it possible to observe variation in external audit choice.
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Transparency, Ownership, and Financing Constraints in Private Firms
