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Agency Problems, Auditing, and the Theory of the Firm: Some Evidence

This paper examines the history of auditing in the U.K. and the U.S. to test whether audits of companies arose as the consequence of governmental regulation or as a voluntary monitoring activity to reduce agency costs and increase firm value. The paper finds that audits existed early in the development of the modern corporation (as early as 1200) and evolved gradually into the type of audit required by the first English companies act (1844). The evidence suggests that the audit's monitoring activity is important, if not crucial, to the formation of firms. The audit's long survival suggests it is a part of the efficient technology for organizing firms. Differences in the timing of the evolution of professional auditors in the U.K. and U.S. prior to legally required auditing appear to reflect differences in the timing of capital market development in the two countries.