Entrepreneur Choice of Auditor and Retained Ownership in IPO Markets: Experimental Evidence

44 Pages Posted: 21 Jun 2000

See all articles by Brian W. Mayhew

Brian W. Mayhew

University of Wisconsin - Madison - Department of Accounting and Information Systems

Jeffrey W. Schatzberg

University of Arizona - Department of Accounting

Galen R. Sevcik

Georgia State University

Date Written: June 25, 2001

Abstract

We use experimental economic markets to test the Datar, Feltham and Hughes (DFH) (1991) model of entrepreneur choice of auditor and retained ownership in initial public offering markets. The mixed evidence provided by prior research using archival data motivated our experimental approach. Experimental markets inherently exhibit considerably more control over the model's decision variables than do archival studies. This enables us to test whether the model adequately describes human behavior and examine the effect of an important decision variable cited by prior research.

Our results provide considerable support for the DFH model of entrepreneur behavior in treatments where investors are programmed to price consistent with the DFH equilibrium. We also found support in similar treatments for a modified DFH model that included the impact of client risk on auditor fees. However, the model was far less predictive of entrepreneur behavior in markets with human investors instead of programmed investors. The results suggest that human entrepreneurs and investors adapt to the choices each made within a particular market, such that less than half of the markets conformed to DFH's predictions while the rest followed an alternative equilibrium where only the entrepreneur's choice of auditor signaled firm value. Our results suggest that in signaling models like DFH, theorists should consider market environments and interactions that can lead to one equilibrium versus another.

JEL Classification: M49, D82, C91

Suggested Citation

Mayhew, Brian W. and Schatzberg, Jeffrey W. and Sevcik, Galen R., Entrepreneur Choice of Auditor and Retained Ownership in IPO Markets: Experimental Evidence (June 25, 2001). Available at SSRN: https://ssrn.com/abstract=229561 or http://dx.doi.org/10.2139/ssrn.229561

Brian W. Mayhew (Contact Author)

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-262-2714 (Phone)
608-263-0477 (Fax)

Jeffrey W. Schatzberg

University of Arizona - Department of Accounting ( email )

McClelland Hall 301
Tucson, AZ 85721
United States
520-621-2238 (Phone)
520-621-3742 (Fax)

Galen R. Sevcik

Georgia State University ( email )

P.O. Box 3989
Atlanta, GA 30302-3989
United States
404-413-7231 (Phone)
404-413-7203 (Fax)

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