The Impact of Venture Capitalists on the Demand for the External Audit Function in Initial Public Offerings

Abstract:     
This paper examines the interaction of a little-studied stakeholder - the venture capitalist (VC) - with the audit function in the initial public offering (IPO) market. While the monitoring role of the external auditor has been studied in the IPO accounting literature, a relatively recent stream of research has begun to provide insight regarding the impact on a firm's reporting and accounting decisions/quality of other potential monitors - e.g., boards of directors, actuaries, etc. Finance and accounting research have both provided evidence consistent with the notion that VCs play a value-added role in their investee firms. This paper contributes to this stream of study by providing first time evidence that in an IPO context a VC provides monitoring value incremental to that of the external auditor. Specifically, our evidence suggests that VCs not only mitigate the demand for information from the external auditor, but that they also weaken the demand for insurance from the external audit function. To our knowledge this result has not been previously documented.

Keywords: Venture capital, Market for audit services

JEL Classification: M41, M49, G24

working papers series