Size Management by European Private Firms
to Minimize Disclosure and Audit Costs*
Darren Bernard
Ph.D. Student
University of Washington
David Burgstahler
Julius A. Roller Professor of Accounting
University of Washington
Devrimi Kaya
Assistant Professor
University of Erlangen-Nürnberg
October 13, 2014
Abstract
Mandated public disclosure of financial statement information potentially subjects the firm to
proprietary costs. In Europe, disclosure requirements increase at “bright-line” firm size
thresholds, creating incentives to manage size to remain below the thresholds. We examine
evidence of size management among small private firms, a setting where proprietary costs of
disclosure should be relatively important. Audit requirements for these firms are also linked to
size thresholds. In situations where the disclosure and audit thresholds coincide, we find
substantial evidence that firms manage size to remain below the threshold, which suggests that
combined costs of mandated disclosure and net audit costs exceed the costs associated with size
management. In settings where the disclosure and audit thresholds are separate, we find 1) no
significant evidence of size management to remain below the disclosure threshold, but
2) significant evidence of size management to remain below the audit threshold. This evidence
suggests the costs of mandated disclosure are typically smaller than the costs of size management
while net audit costs are typically larger than the costs of size management. Because net audit
costs are relatively low for small private firms, the empirical evidence provides little support for
the proposition that mandatory disclosure of financial statement information imposes substantial
proprietary costs.
*
We thank participants at the 2013 UBCOW Conference, the 2013 and 2014 EUFIN Conferences, the 2014
Potsdam Auditing and UTS Accounting Research Workshops, an anonymous reviewer for the 2014 EAA
Conference, and Nicole Cade, Francesca Cesaroni, Jill Collis, Belén Fernández-Feijóo, Luzi Hail, Katerina
Hellström, Klaus Henselmann, David Huguet, Bill Kinney, Robert J. Kirsch, Clive Lennox, Sarah McVay, Lasse
Niemi, and Brady Williams for helpful comments on earlier versions of this paper. David Burgstahler gratefully
acknowledges the generous financial support of the Dr. Theo and Friedl Schöller Foundation.
1. Introduction
A growing body of literature examines the proprietary costs of firm disclosure (Ellis, Fee,
and Thomas [2012]; Bens, Berger, and Monahan [2011]; Dedman and Lennox [2009];
Verrecchia and Weber [2006]; Botosan and Stanford [2005]; Harris [1998]; Hayes and
Lundholm [1996]). The premise of most papers in this area is that managers choose to withhold
information that could competitively disadvantage the firm – for example, when product market
rivals could use disclosed information to redirect investment or financing policy or enter
profitable product markets. While prior papers examine a variety of quantitative and qualitative
disclosures, there is limited evidence on the economic significance of proprietary costs that stem
specifically from the disclosure of financial statement information (Beyer et al. [2010]).1
Whether the disclosure of financial statement information imposes economically
significant proprietary costs is an open – and important – empirical question. On the one hand, as
European regulators have noted (e.g., DTI [1995]), financial statement disclosures are often
predictive and reveal information about the firm’s financial health and product market
performance (such as details about margin levels, liquidity constraints, sales trends, and other
items) that might be useful to competitors. On the other hand, there are also factors that might
reduce the usefulness of financial statement information to competitors. For example, accounting
information is typically retrospective, conservative, subject to some amount of managerial
discretion, and presented in aggregated totals on financial statements.
This paper provides evidence on the actions of European firms to avoid proprietary costs
of mandated financial statement disclosure. Virtually all European countries require limited
liability private firms to publicly disclose certain financial statement information, where firm
1
Examples of disclosures examined previously in the literature include the redaction of information from SEC
material contract filings (Verrecchia and Weber [2006]) and compliance with SEC Reg. S-K, which requires US
public firms to disclose information about customers that make up more than 10% of consolidated revenues (Ellis,
Fee, and Thomas [2012]).
1
size determines the extent of mandated disclosure. Disclosure requirements for the smallest firms
are typically minimal, but larger firms that exceed “bright-line” size thresholds face expanded
disclosure requirements.2 Thus, to the extent expanded financial statement disclosures impose
proprietary costs, firms have an incentive to avoid exceeding these size thresholds and thereby
avoid additional disclosure requirements.
Our sample of small private firms in Europe provides a relatively powerful setting to
assess the economic significance of proprietary costs of financial statement disclosure.3 First, the
net incentives to avoid disclosure are likely to be stronger for private firms than for public firms.
Important benefits of disclosure of financial information to owners and capital market
participants offset costs of disclosure to competitors for public firms (see Beyer et al. [2010] for
a review). In contrast, for private firms there are few offsetting benefits of public disclosure. For
example, private firms can often satisfy the information demands of owners and other
stakeholders, such as creditors and suppliers, using only confidential channels (Asker, FarreMensa, and Ljungqvist [2014]). Further, financial statement information is likely to be
incrementally more informative for private firms than for public firms because private firms
typically have far fewer other public disclosures than publicly-owned firms. These characteristics
suggest the net incentives to avoid public disclosure of financial statement information are
stronger for private firms than for public firms.4
2
Generally, firms are classified as small, medium, or large based on three measures of firm size: total assets,
sales, and number of employees. We discuss size classification at greater length in Section 2.
3
The focus of the empirical analysis is on small but not tiny firms. As explained in Section 2, we examine size
management behavior around size thresholds that are typically about 50 employees, 3 to 4 million euro in total
assets, and 6 to 8 million euro in annual sales, although the thresholds vary by country and year.
4
One reason to study private firms is simply that they account for a large portion of economic activity both in
the US and in Europe. For example, Asker, Farre-Mensa, and Ljungqvist [2014] estimate that in 2010, private firms
accounted for more than 68% of private sector employment and almost 49% of pre-tax profits in the US. Brav
[2009] estimates that private firms own roughly two-thirds of corporate assets and represent 97.5% of all
incorporated entities in the UK.
2
Second, we expect proprietary costs of disclosure to be relatively more important for
smaller firms. For large companies, financial statement information is typically aggregated
across multiple product and geographic markets, limiting the usefulness of the information to
competitors. For smaller companies that are more concentrated in a single market, rivals are
likely to glean more useful competitive information from financial disclosures.5
Third, the European setting allows us to hold constant other disclosure-related costs,
including agency costs and the direct costs of financial statement preparation, because most
countries require firms to prepare financial statements irrespective of their public disclosure
requirements.6 For example, the United Kingdom (UK) and Germany require all firms,
regardless of size, to prepare full accounts for shareholders. This requirement ensures that
managers have no incentive to manage firm size downward to remain below size thresholds to
either (1) avoid disclosure of unfavorable information to capital providers (see, e.g., Berger
[2011]) or (2) avoid additional financial statement preparation costs. Thus, in our setting actions
to avoid disclosure requirements are less likely to be attributable to the confounding effects of
other disclosure-related costs.
Fourth, the diversity of the type and extent of additional disclosure required when firms
move above the small-medium disclosure threshold allows us to examine the proprietary costs
imposed by a variety of disclosure requirements. In many European countries, firms below the
threshold are required to disclose only a subset of the financial statements required for firms
above the threshold. For instance, in a number of countries, income statement disclosure is
required for firms above the threshold but not for those below. Additionally, firms below the
threshold are typically permitted to disclose more aggregated information, such as disclosing
5
Similar reasoning motivates prior studies to focus on proprietary information provided by public firm segment
disclosures (Bens, Berger, and Monahan [2011]; Botosan and Stanford [2005]; Harris [1998]).
6
Even when full accounts are not required for non-tax reasons, in much of Continental Europe firms prepare
detailed financial statements as the basis of their tax filings (Burgstahler, Hail, and Leuz [2006]).
3
only gross profit without separately disclosing sales and cost of goods sold or disclosing liability
totals without additional detail about liability components.
Finally, audit requirements for private firms in Europe are typically based on the same
size classification variables and implementation rules (described in Section 2 below) as the
disclosure requirements. In cases where the disclosure and audit threshold values coincide,
actions to remain below the threshold reflect the joint effect of incentives to avoid expanded
disclosure and to avoid mandatory audits. In these cases, we cannot separately observe the
individual effect of either requirement. However, there are also cases where the disclosure and
audit thresholds do not coincide. These cases allow us to separate the effects of mandated
disclosure versus audit requirements and thereby draw inferences about the relative importance
of disclosure costs versus audit costs to small private firms.
Results are presented in two sections. In the first section, we present evidence of size
management for those countries where disclosure and audit thresholds coincide for most or all of
the sample period, with a focus on four of the largest countries with the largest sample sizes.
Significance tests strongly support the notion that firms manage size to remain below coinciding
disclosure and audit thresholds. In a number of cases, the percentage of firm years managed at
the threshold is between 10-20%, consistent with the hypothesis that the combined costs of a
mandatory audit and proprietary disclosure costs are greater than the cost of managing size for a
significant proportion of firms. Further, as expected, the results show substantial variation across
countries in the type and extent of size management activity.7 For instance, whereas UK firms
heavily manage total assets, Spanish firms manage all three size variables – total assets, sales,
and number of employees.
7
Analogously, prior literature finds substantial differences in the extent of earnings management activity across
European countries (e.g., Burgstahler, Hail, and Leuz [2006]; Joos and Lang [1994]). An important benefit to
examining a large number of European countries is that this approach provides evidence of robustness, ensuring that
our inferences are not driven by an idiosyncratic institutional factor in any specific country.
4
In the second section, we expand the analysis and include cases where disclosure
thresholds do not coincide with audit thresholds. In these cases, we find no significant evidence
that firms manage size to remain below the separate disclosure threshold and thereby avoid
additional disclosure requirements. In contrast, we find strong and consistent evidence that firms
manage size to remain below the separate audit threshold. This combination of evidence suggests
that the magnitude of disclosure costs is substantially smaller than the magnitude of net audit
costs, and that the size management observed in cases where the thresholds coincide is more
likely to be due to audit costs than disclosure costs.
Our study makes several contributions. First, we extend the literature by examining
evidence of proprietary costs stemming from various types of expanded disclosure requirements
for small private firms, which have relatively strong net incentives to avoid public disclosure.
There is a notable lack of evidence that firms are willing to manage size by small amounts solely
to avoid expanded disclosures, even when the incremental required disclosure involves
additional financial statements, such as the cash flow statement or the income statement. The
lack of evidence of size management at disclosure thresholds is even more striking given the
strong and consistent evidence of size management at audit thresholds, as net audit costs are
likely to be relatively low for the small private firms in our setting. More generally, the evidence
(1) calls into question the economic significance of proprietary costs stemming from financial
statement disclosures, and (2) underscores Berger’s [2011] concern that tests of proprietary costs
in the literature may also capture agency and other disclosure-related costs.
Second, our results may be of interest to European policymakers. Though the results cast
doubt on regulator concerns about the competitive costs imposed on private firms by disclosure
requirements (DTI [1995]), the evidence does suggest that firms manage size to avoid mandatory
5
audit requirements, consistent with broader concerns about the costs of regulatory requirements
imposed on small firms in Europe (European Commission [2010]).
Third, we contribute to the accounting and economics literature that studies the
management of economic variables around regulatory thresholds and salient benchmarks. For
example, Gao, Wu, and Zimmerman [2009] find evidence that small public companies in the US
took actions to reduce their public float and thereby postpone compliance with Section 404 of the
Sarbanes-Oxley Act. Our evidence reinforces the notion that firms opportunistically manage size
variables around regulatory thresholds in a setting where the thresholds determine the extent of
audit requirements.
2. Institutional Background
2.1 DISCLOSURE AND AUDIT ENVIRONMENT OF EUROPEAN PRIVATE FIRMS
The European Commission and the national governments of Europe strongly influence
the disclosure and audit environment of European private firms. Although national governments
are ultimately responsible for setting and enforcing accounting and disclosure requirements,
directives from the European Commission establish a broad framework within which national
governments exercise discretion. Over time, as Europe has moved towards greater integration on
issues of economic and monetary policy, so too have national governments converged on issues
of accounting and disclosure policy. The implementations of the Fourth and Seventh EU
Accounting Directives (“Fourth Directive” and “Seventh Directive,” respectively) and the EU
Corporate Disclosure Directives (1968 and 2003) have driven much of this harmonization.
European countries generally require smaller firms to comply with fewer of the
accounting and disclosure requirements in EU Directives. Each country implements rules to
classify firms into size categories (small, medium, or large), which determine two key
requirements facing limited liability private firms in Europe. First, size classification dictates
6
public disclosure requirements.8 While all limited liability firms are required to disclose some
financial information so suppliers, customers, and the broader public can obtain information
about firms whose owners enjoy limited liability, the disclosure requirements increase
substantially with a firm’s size classification. For instance, small firms in the UK and Germany
are required to disclose (at a minimum) an abbreviated balance sheet, but are not required to
disclose an income statement or the average number of employees. In contrast, medium and large
firms must disclose an income statement with accompanying notes disclosures, in addition to
other information.9 Table 1 summarizes the main disclosure requirements for firms below versus
above the small-medium threshold in each of the sample countries, and Appendix 1 provides
further details.10
Second, in most European countries, limited liability private firms classified as medium
or large are required to have an external audit every year, whereas firms classified as small are
typically exempt from audit requirements. Appendix 2 provides detailed information on audit
requirements in each of the sample countries.
Individual countries implement their own size thresholds based on guidance from the
European Commission. Generally, firms are classified as small, medium, or large based on three
8
As of January 1, 2007, all filed financial statements must be available in electronic format from national central
registers for free or a small nominal fee. Prior to 2007, some countries relied on a different disclosure channel for
limited liability firms. For instance, until 2007 German firms disclosed company information at local company
registers, which local courts managed. The local courts informed the public of filings via an announcement in the
Federal Gazette (Bundesanzeiger).
9
Section 411 I of the UK Companies Act and Section 288 I of the German Commercial Code.
10
We limit our focus to the small-medium threshold for several reasons. First, the incremental increase in
required disclosure at the small-medium threshold is generally substantially greater than at the medium-large
threshold. Indeed, the disclosure requirements for medium-sized firms shown in Table 1 and Appendix 1 are
identical to the requirements for large firms in 6 of the 12 sample countries (Belgium, Denmark, Finland, France,
Italy, and Sweden). In the 6 remaining countries, there are some differences in disclosure requirements for medium
versus large firms, but the incremental required disclosure generally involves relatively minor changes in the level of
aggregation for specific financial statement accounts. Second, as discussed above, the operations of smaller firms
are generally more concentrated, which makes it more likely that their competitors can attribute disclosed
information to specific product or geographic markets. Third, the much larger number of firms at the small-medium
threshold compared to the medium-large threshold makes it more likely that our tests have sufficient power to detect
size management. Finally, audit requirements are typically imposed at the small-medium threshold, which is an
important aspect of the research design, as explained further below.
7
variables: year-end total assets, annual sales, and average number of employees during the firm’s
fiscal year. Firms are usually assigned to a larger size category when the values of two (or more)
of the three size variables exceed pre-defined bright-line thresholds over two successive years.11
For example, a small firm moves up to become a medium firm as soon as at least two of three
size variables exceed the threshold separating the small and medium size classifications for two
consecutive years. Conversely, a medium firm does not move down to the small size class until
at least two of three size variables remain below the small-medium size threshold for two
consecutive years.
Table 2 lists the small-medium size thresholds in effect during our sample time period
(January 1, 2003 through December 31, 2011) for the twelve sample countries. Two important
institutional details are apparent. First, in most countries, all limited liability firms were subject
to disclosure and audit requirements imposed at size thresholds since the start of the sample
period or before.12 The audit size thresholds in the Scandinavian countries are the exceptions. It
was not until late in the sample period (2011 in Sweden, 2008 in Finland, and 2006 in Denmark)
that an audit exemption for some limited liability firms was introduced in these countries.
Further, once the exemption was introduced, it was only for extremely small firms (e.g., the
employee threshold in Finland and Sweden was set at 3 employees). Because firms must remain
extremely small to avoid an audit in the Scandinavian countries, firms are likely to have
unusually weak incentives to avoid mandatory audits in these unique settings, consistent with
survey evidence on these regulation changes (see Niemi [2004]). Therefore, we do not present
evidence on size management at the audit thresholds in the Scandinavian countries.
11
The UK and Ireland provide minor exceptions to the usual size classification rule for audit requirements (but
not disclosure requirements). Until 2013 in Ireland, firms that exceeded three of three size variables were assigned to
the larger size category. Until 2012 in the UK, firms that exceeded either the sales or asset threshold were assigned
to the larger size category.
12
In fact, disclosure and audit requirements have been in effect in most of the sample countries since the 1990s
or before. For simplicity, we only show the threshold levels in effect during our sample period in Table 2.
8
Second, threshold levels are updated to account for inflation and changes in other
economic factors, though some countries (such as Germany) update their thresholds more
frequently than others (such as France or Spain). For countries that have updated their threshold
levels, the assets and sales thresholds have generally increased at a rate that has significantly
outpaced inflation, effectively expanding the set of firms that fall in the small size category (and
therefore expanding the set of firms that are exempt from audit or additional disclosure
requirements). This is consistent with the concerns of both the European Commission and
national governments about imposing proprietary disclosure costs and audit costs on small and
medium-sized enterprises (DTI [1995]). There has not been a corresponding relaxation over time
in the employee threshold – the small-medium threshold for the employee size variable is 50 in
most countries and has remained unchanged in almost all countries since the beginning of our
sample period.
2.2 MANAGEMENT OF SIZE CLASSIFICATION VARIABLES
Size classification depends jointly on the values of three size variables – total assets,
sales, and number of employees. Managing one or more of these size variables downward
imposes costs that include the costs of operating at a suboptimal size as well as costs of
maintaining the size variables below thresholds. These costs are likely to be lowest when the
unmanaged size variables are only a small amount above the thresholds, so we expect most
evidence of size management to reflect managers’ actions to reduce size variables by only a few
percent. We briefly review some of the tactics used to manage each of the three variables as
highlighted in the academic and practitioner literatures in Europe.13
13
A comprehensive way to manage size to remain below size thresholds is to restructure the firm into two or
more separate firms. Size management through restructuring will affect the distributions of all three size variables in
ways that are difficult to detect empirically, as splitting the firm transforms values near or above thresholds into
values substantially below thresholds. However, in the tests that follow, we benchmark evidence of size
management at disclosure thresholds using evidence of size management at audit thresholds, and there is no reason
to expect that firms are more likely to restructure instead of manage size variables individually to avoid disclosure
9
2.2.1. Total Assets
Firms can manage total assets downward using a variety of techniques that keep assets
off the balance sheet. Examples include leasing rather than buying, outsourcing asset-intensive
business processes, and financial transactions such as factoring. Of course, any size management
action that involves an outside entity entails both monetary and time costs from contracting.
Firms can also use accounting discretion to manage assets. For instance, under the
German Commercial Code firms have several options to either expense or capitalize costs, e.g.,
firms can expense the costs of an internally generated intangible asset from the development
phase (Section 248 II) or expense loan discounts (Section 250 III). Accrual management is
another possibility. Due to the close alignment of tax reporting with financial reporting in
Continental Europe (Burgstahler, Hail, and Leuz [2006]), asset write-offs might be used to
simultaneously manage assets downward and reduce tax liabilities. Another advantage to using
accounting discretion is that it requires less advance planning – managers can make opportunistic
accounting decisions after the fiscal year end while preparing the financial statements. The
disadvantages are that such actions are not permanent (accruals, for example, can reverse in the
following year) and can attract the attention of tax authorities.
2.2.2. Sales
Firms have several options to manage sales downward. In some circumstances reported
sales can be reduced through accounting choices, e.g., by recording sales at net amounts after
deducting some costs. In some cases firms can separate sales revenue and revenue from ancillary
services such as delivery or warranty service, where the ancillary revenue might be allocated to a
separate (though possibly affiliated) firm. Another possibility that does not rely on accounting
discretion is to simply defer sales to a subsequent period (e.g., by underestimating the stage of
versus audit requirements. For a more extensive discussion of restructuring and other methods firms can use to
manage each size variable, see Kaya [2010, pp. 128-156].
10
completion of long-term contracts to delay revenue recognition), though delaying revenue
recognition only defers the issue of maintaining sales below the size threshold. Managers might
also fail to report cash sales; however, given the high book-tax alignment in most of Europe,
doing so would risk drawing the scrutiny of tax authorities (Burgstahler, Hail, and Leuz [2006]).
2.2.3. Number of Employees
Employee count can be managed by using temporary employees, by outsourcing, or by
contracting with outside entities to supply labor. For example, in most European countries,
services are readily available for straightforward financial functions such as payroll, billing, and
processing of receivables and payables. However, these nonstandard employment relations are
often costly and require substantial planning to establish. For example, in Germany, firms
typically pay two to three times more for a temporary worker from an outside entity than for an
internal employee (Holtbrügge [2007]).
3. Hypotheses and Related Literature
3.1 SIZE MANAGEMENT TO AVOID DISCLOSURE COSTS
Prior theoretical and empirical papers consider the incentives for firms to withhold
information for competitive reasons. The premise of these papers is that disclosures that provide
competitors with useful information can impose proprietary costs. Accordingly, the literature has
focused on the determinants of competitive costs of disclosure, including the firm and industry
characteristics associated with high proprietary costs.
Most papers examine disclosures other than financial reporting outputs. For example, a
number of papers examine the quality of compliance with nonfinancial disclosures in public
firms’ mandatory filings. Ellis, Fee, and Thomas [2012] examine firm compliance with SEC
Reg. S-K, which requires public companies to disclose information about major customers;
Verrecchia and Weber [2006] study the redaction of information from SEC material contract
11
filings; and Guo, Lev, and Zhou [2004] examine the extent of product-related information in a
sample of biotech firm prospectuses. Previous papers also examine the relation between
proprietary costs and voluntary financial disclosures. For instance, Wang [2007] studies the
propensity of managers to provide “private” earnings guidance, and Bamber and Cheon [1998]
examine managers’ decisions to provide qualitative instead of quantitative forecasts.
While the universal conclusion of these papers is that firms with higher proprietary costs
make less informative disclosures, it is generally not clear what costs, if any, firms incur to make
less informative disclosures (see, e.g., Verrecchia and Weber [2006]). Further, there is
substantial inconsistency in the assumptions about the firm and industry characteristics
associated with high proprietary costs. For instance, Harris [1998] and Botosan and Stanford
[2005] examine proprietary costs of disclosure in the context of multi-segment reporting under
SFAS No. 14 and SFAS No. 131. Both papers report evidence consistent with the assumption
that managers choose segment disclosures opportunistically to hide information about product
lines in less competitive (and, presumably, more profitable) industries. On the other hand,
Verrecchia and Weber [2006] find that nondisclosure (that is, redaction from SEC material
contract filings) is more common in more competitive industries and among firms experiencing
losses. Dedman and Lennox [2009] examine medium-sized UK private firms’ use of an
exemption to avoid disclosure of sales and cost of goods sold. They argue that measures of
industry competition face too many theoretical and empirical problems to be useful predictors of
firms’ proprietary costs and find little evidence that industry measures of competition are related
to disclosure decisions.14
14
Interestingly, Dedman and Lennox [2009] also find that while most medium-sized firms choose to disclose as
little as possible to meet disclosure requirements, nearly half of the firms in their sample choose to not incur what
appears to be a very small nominal cost (£100 – £250) to avoid more detailed disclosure.
12
We focus on proprietary costs that stem specifically from financial statement disclosures
for two main reasons. First, financial reporting outputs capture measures of firm performance
and financial position that are potentially of interest to rivals. For example, a competitor could
use sales, gross profit, and operating profit disclosures to infer the success of the recent
introduction of a new or revamped product line, advertising campaign, or capacity expansion. A
rival could use knowledge of a competitor’s recent price changes together with financial
statement disclosures to better understand market size and price elasticities in specific market
segments. Competitors could use income statement, balance sheet and notes disclosures to
benchmark their own sales growth, production efficiency, SG&A costs, collection and payment
periods, inventory levels, or PP&E levels (Lang and Sul [forthcoming]). Competitors could even
use expanded balance sheet and cash flow statement disclosures to identify and prey on weaker
rivals, consistent with evidence from the capital structure literature that suggests that firms
undercut highly levered and cash-constrained rivals in competitive product markets (see, e.g.,
Chevalier [1995]).
Second, financial statement disclosures are likely to be especially informative for small
private firms, as there are few, if any, alternative low-cost sources of information for these firms.
Further, small private firms typically have concentrated ownership and can effectively rely on
confidential channels for dissemination of financial statement information to key counterparties.
Combined with the fact that public disclosure provides private company owners with no equity
market benefits, these characteristics of the setting make it likely that mandated public disclosure
imposes relatively high proprietary costs for firms in our sample.
In sum, we examine evidence of size management to avoid substantial expansions in
financial statement disclosure among firms that are likely to incur relatively high proprietary
13
costs of disclosure.15 Firms are likely to manage size only if the proprietary costs of disclosure
are greater than the operational and financial costs of size management activities. Because the
costs of size management increase with the amount of size management, most instances of size
management are likely to be those that reduce size variables from levels just above the size
threshold to levels just below. Thus, we expect to find evidence of size management to avoid
disclosure unless the proprietary costs of disclosure are even smaller than the costs of small
amounts of size management.
Our first hypothesis, in alternative form:
H1: European private firms manage size to avoid competitive costs of disclosure.
3.2 SIZE MANAGEMENT TO AVOID AUDIT COSTS
The net cost of an audit is the gross cost of the audit (the sum of direct audit fees and
other indirect costs, such as the time and effort to provide information to the auditors) less any
offsetting benefits of the audit. Direct audit fees are typically relatively low for small private
firms. For example, audit fee estimates for most small UK firms range from £1,000 to £10,000
during our sample period, depending on the firm’s audit history, industry, and other factors
(Kausar, Shroff, and White [2014]; Collis [2010]; Collis [2008]). Audit fees are likely to be even
smaller in countries with less stringent audit requirements. For example, in some countries the
external auditor does not need to be certified (e.g., the Netherlands – see Appendix 2), which is
likely to translate into lower audit fees. In other countries (e.g., Italy – see the discussion in
Section 5.1 and Appendix 2) an internal board of statutory auditors can conduct the audit, which
is likely to lead to even smaller costs. The indirect costs of an audit are hard to quantify for small
private firms, but are they likely to be minimal inasmuch as European countries often require
15
In this way, our paper can be viewed as an extension of Dedman and Lennox [2009]. While Dedman and
Lennox [2009] examine proprietary costs imposed by the disclosure of separate sales and cost of goods sold
information in the UK, we examine a broader range of disclosure requirements in multiple countries.
14
firms to prepare full accounts for shareholders, which means that firms incur the costs to keep
reasonably accurate books and records regardless of external audit or public disclosure
requirements.
The offsetting benefits of an audit can be described in terms of reductions of monitoring
and contracting costs. The separation of ownership and control creates a demand for monitoring
(Jensen and Meckling [1976]), and audits can substitute for other costly forms of monitoring by
owners and company directors (Collis [2010]; Güntert [2000]). Further, audits can improve
managerial decision making by providing assurance that the financial statement figures used for
planning and control purposes are reliable.
Audits can also reduce debt contracting costs, which are often substantial for private
firms (Brav [2009]). Using a sample of small US firms, Blackwell, Noland, and Winters [1998]
show that firms that choose to be audited pay significantly lower interest rates than similar
unaudited firms. In their sample, the interest savings from audits cover between 28% and 50% of
typical audit fees. Minnis [2011] finds that audited firms enjoy significantly lower interest rates
than unaudited firms (roughly 70 basis points, on average), with larger effects on rates for
smaller firms. Minnis [2011] also finds evidence of a “substitution effect” for internal firm
capabilities – that is, the greater rate reductions from audits for small firms suggest that lenders
price in an expertise effect from auditor involvement on financial reporting quality.
Lennox and Pittman [2011] highlight the endogeneity of lower interest rates associated
with voluntary audits. Drawing on Melumad and Thoman’s [1990] analytical model of audit
choice, they argue that the decision to hire an auditor acts as a mechanism that permits a
separating equilibrium between low- and high-risk borrowers. They focus on firms that were no
longer required to have an audit due to a change in audit thresholds in the UK in 2004 and find
that credit ratings increase for firms that choose to continue to be audited, whereas credit ratings
15
fall for firms that discontinue their audits. Kausar, Shroff, and White [2014] use the same setting
to show that voluntary audits allow high-quality firms to signal their type by choosing to be
audited, which affects the investment and long-term debt levels of firms that transition from
mandatory to voluntary audit regimes. Together, these findings suggest that managers’ decisions
regarding audits can act as valuable signals to outside parties; however, the value of these signals
are likely to be substantially lower in a mandatory audit regime.
In sum, the gross cost of an audit may be partially or completely offset by reductions in
agency costs and other benefits. Previous evidence suggests the benefits of an audit are likely to
be relatively high for small private firms, which often rely heavily on debt and may lack
alternative control systems. When the benefits completely offset the costs, the firm chooses to
have an audit independent of regulation. However, even when the benefits do not completely
offset the costs, the net cost of an audit may be so small that firms are unwilling to incur the
costs of size management to avoid an audit. Thus, the extent to which private European firms
manage size to avoid audit requirements is an open empirical question. Our second hypothesis, in
alternative form:
H2: European private firms manage size to avoid mandatory audits.
Together, results for H1 and H2 provide evidence about the relative magnitude of
proprietary costs of disclosure versus net audit costs. Evidence of size management to avoid
disclosure but not to avoid audits would suggest that disclosure costs exceed net audit costs.
Alternatively, evidence of size management to avoid audits but not to avoid disclosure would
suggest that disclosure costs are less than net audit costs.
16
4. Sample Selection, Empirical Methodology, and Descriptive Statistics
4.1 DATA AND SAMPLE SELECTION
We obtain financial statement and employee data from Amadeus, the leading data source
for European private firms (e.g., Tendeloo and Vanstraelen [2008]; Burgstahler, Hail, and Leuz
[2006]; Coppens and Peek [2005]). The Amadeus database, supplied by Bureau van Dijk,
contains information about a wide range of public and private European firms. Amadeus
dramatically expanded its coverage of private firms in the early 2000s, so we focus on a nineyear period beginning in 2003, when data availability increases substantially in a number of
countries.
We select observations from twelve countries, which represent some of the largest
European economies with the largest number of observations available on Amadeus: Austria,
Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Spain, Sweden,
and the UK.16 The decision to examine a large number of countries stems from our expectation
that the net cost of managing each size variable (and therefore which variables are managed and
to what extent) varies across countries, as a large body of literature documents the effects of
certain institutional factors on accounting-related decisions, such as earnings management
(Burgstahler, Hail, and Leuz [2006]; Maijoor and Vanstraelen [2006]; Leuz, Nanda, and
Wysocki [2003]; La Porta et al. [1998]; Joos and Lang [1994]).17 Thus, examining evidence of
size management to avoid mandatory disclosure and audit requirements across a large number of
countries reduces the probability that our main conclusions are affected by any country-specific
institutional detail.
16
For the remaining European countries not included in our sample, there are only a limited number of
observations available on Amadeus, and expanding the sample to include these countries would impose substantial
costs to accurately identify specific disclosure and audit requirements.
17
As discussed further below, we also believe that regulators’ decisions in setting the relative levels of the total
assets, sales, and employee count thresholds could affect which size variable or variables firms manage.
17
Consistent with the application of national size classification criteria, we restrict our
sample to the (unconsolidated) financial statement accounts of firms not in a consolidated group.
We also restrict the sample to private firms, as publicly-traded firms are all subject to public
disclosure requirements, and to firms not in finance, insurance, or public administration (NAICS
codes beginning with 52 and 92), as firms in these industries are often subject to other disclosure
and audit requirements under national laws (e.g., Lennox and Pittman [2011]). Finally, we
include only firms with limited liability, as firms without limited liability are not subject to
disclosure or audit requirements, and firms not reporting under IFRS, as private firms that
voluntarily adopt IFRS are likely to have different disclosure incentives compared to firms that
do not.
Table 3 summarizes the sample selection procedure (Panel A) and details the total
observation count by year and country (Panel B).18 The population of firms we examine
comprises roughly 37 million firm-year observations, though we focus on a small subset of these
observations (that is, observations in the immediate vicinity of the disclosure or audit
thresholds), as we expect to observe size management only when the costs of size management
are small relative to the benefits. We provide two measures of the number of observations close
enough to the thresholds to be potentially affected by size management in Table 3 Panel C. First,
we tabulate the number of observations within ten percent of the total assets disclosure threshold
for each country. Second, to approximate the number of firms in the sample that could
18
Table 3 Panel B shows that our sample size generally increases over time. There are several reasons for this
increase. First, data coverage on Amadeus expanded over the 2000s. Second, some countries implemented stronger
enforcement systems to improve disclosure compliance during the sample period, leading to a substantial year-overyear increase in observations. For example, in 2006 Germany created new rules that target firms that fail to file
mandatory financial statement information. Third, Bureau van Dijk deletes observations in Amadeus from previous
years when firms fail to file financial statements for four years. For example, observations for a firm that filed
financial statements until 2004 when it went bankrupt would not be included in our dataset, as it would not have
filed financial statements for four years when Bureau van Dijk updated the Amadeus dataset in 2012 and 2013,
when we retrieved our data. Overall, this has the effect of reducing the sample size in the earliest years of the
sample, but not in the most recent years. We have no reason to believe these systematic changes in database
coverage affect the inferences from our results.
18
reasonably be expected to manage size downward to avoid disclosure or audit costs, we tabulate
the number of observations within four percent above the total assets disclosure threshold for
each country. For example, of the approximately 4.7 million firm-year observations from Spain
that meet the sample selection criteria, only roughly 94,000 (18,000) are within ten percent of
(four percent above) the total assets disclosure threshold.
4.2 EMPIRICAL METHODOLOGY
If firms take actions to manage size in the vicinity of the thresholds, these actions will be
reflected in the distributions of the size variables (total assets, sales, and number of employees).19
Specifically, we hypothesize that firms take actions to transform pre-managed size variables a
small amount above the threshold into post-managed values below the threshold.20 As a result,
size management will lead to an abnormally high number of firm-year observations immediately
below a size threshold in the observable post-managed distribution and an abnormally low
number immediately above the threshold.
We use distributional tests popularized in the earnings management literature (see, e.g.,
Burgstahler and Dichev [1997]) to test our predictions. Distributional tests offer two key
advantages over alternative approaches. First and foremost, distributional tests do not require a
model of the “normal” values of variables subject to management. This is important as such
models are often noisy (see, e.g., Dechow, Sloan, and Sweeney [1995] and Dechow et al. [2012]
19 Because the firms managing size at some thresholds avoid mandatory audit requirements, it is conceivable that
firms are simply misreporting their size rather than actually making different economic decisions because of the size
thresholds. We believe this is unlikely for several reasons. First, as discussed above, there is high tax-financial
reporting alignment in Continental Europe (see Table 3 in Burgstahler, Hail, and Leuz [2006]). Since financial
statements are the basis of tax filings, financial statements are effectively under the scrutiny of tax authorities.
Second, national laws impose significant penalties on managers and directors for misleading or false financial
reporting. For instance, under the 2006 Companies Act in the UK, directors must acknowledge their responsibilities
for ensuring their companies keep appropriate records and prepare financial statements “which give a true and fair
view of the state of affairs of the company.” Under German law (Section 331 of the German Commercial Code),
false reporting can result in financial penalties or imprisonment for up to three years. These institutional
characteristics suggest that size management in the form of false reporting is costly to firms and their managers.
20
For expositional convenience, we describe firms managing size to remain below disclosure and audit
thresholds. Technically, however, firms avoid size re-classification by managing size to remain at or below
thresholds.
19
for a discussion of abnormal accrual models), and these models also require a large set of data
from surrounding years. Second, as explained below, distributional evidence can be used to
assess the frequency of size management.21
Consistent with prior literature, our tests assume only that the distributions of the
variables are smooth in the absence of size management. To this end, we select bin sizes to be
roughly two percent of the variable threshold – large enough to maintain the assumption of
smoothness in the absence of management, but small enough so that it is plausible that firms
could manage the variables by the amount of the interval width at reasonably low cost.22 For
example, it is plausible that to avoid an audit a firm could reduce its headcount from 51 to 50
(i.e., about 2%) at reasonably low cost, but it is much less plausible that the firm would incur the
costs necessary to reduce headcount from 60 employees to 50 employees.
The significance of each discontinuity is assessed using the standardized difference
statistic defined in Burgstahler and Dichev [1997], incorporating the minor refinements
presented in Burgstahler and Chuk [2014]. The hypothesis that size variables are managed
downward to remain below size thresholds predicts a positive standardized difference for the
interval immediately below the threshold (“left standardized difference”) and a negative
standardized difference for the interval immediately above the threshold (“right standardized
difference”).23 For expositional convenience, we present and discuss results for left standardized
21
Durtschi and Easton [2005] and Durtschi and Easton [2009] question the conclusions of distributional tests in
the earnings management literature. In short, they argue that scaling and sample selection issues can bias the results
of distributional tests. Neither of these criticisms bears on our results: we do not scale our variables by another
variable, and we obtain significant results for all three variables that we test, including total assets, which firms must
disclose regardless of size (i.e., there are very few missing observations for assets). Also, see Burgstahler and Chuk
[forthcoming] for a rebuttal to the Durtschi and Easton claim that discontinuities are explained by scaling and
selection.
22
Our results are not sensitive to other reasonable choices of bin size.
23
Note that the predictions about standardized differences for size variables that are managed down to remain
below thresholds have the opposite signs compared to earnings variables that are managed up to exceed thresholds.
20
differences, noting that inferences are generally unchanged if we instead focus on right
standardized differences.
4.3 DESCRIPTIVE STATISTICS
Table 4 presents descriptive statistics for the three size variables by country. The
descriptive statistics highlight the large proportion of private firms in European economies that
are small. Comparing the percentile values of variables for which we have relatively complete
data (e.g., total assets for firms in the UK or sales for Italian firms) to the thresholds in Table 2,
the vast majority of firm-year observations on Amadeus are below the small-medium threshold –
for example, the 90th percentile for these variables is typically below the small-medium
threshold. The large proportions of small firms in the sample are also reflected in the data
coverage statistics in the far right column of Table 4. Small firm disclosure requirements include
at least an abbreviated balance sheet (and therefore, total assets) for every country, but in many
countries small firms are not required to report sales or employee count. Consistent with these
requirements, the data coverage statistics for these countries show a relatively large proportion of
missing sales and employee count observations.24
Missing data for sales and employee count impose a limitation on our tests, as nondisclosure among firms below the small-medium size threshold could reduce (though could not
increase) the observed effects of size management. For example, under the simplifying
assumptions that firms do not voluntarily disclose more than is required and that size
classification is determined based solely on the value of a single size variable for a single year,
24
Note, however, that the low coverage rates for sales and employees in Table 4 tend to exaggerate the
importance of missing data, since the vast majority of the missing sales and employee count observations are likely
far below the small-medium size thresholds. For example, untabulated results show that roughly 90% of the
observations of UK firms with missing employee data have total assets less than £1,000,000, which is far below the
disclosure and audit thresholds based on asset size during our sample period. The missing sales and employee
observations that correspond to these small asset-size observations would likely have also been far below the
respective sales and employee thresholds for the vast majority of observations, and thus would not have had any
effect on tests of size management in the vicinity of the thresholds.
21
the sales and employee size data would be missing below thresholds that impose sales and
employee count disclosure. This censoring of sales and employee observations below the
disclosure thresholds would eliminate the excess observations below the threshold that are
expected under the size management hypothesis. However, the simplifying assumptions do not
hold exactly – firms sometimes voluntarily disclose and the actual size classification criteria are
complex, based on the values of two of three size variables for two consecutive years. As a
result, it is impossible to know exactly the extent to which observations below the size thresholds
for the sales and employees variables have actually been censored; Table 4 shows that sales and
employee count data are often available for values below the disclosure thresholds.
Despite the limitations imposed by non-disclosure, we believe it is useful to examine
evidence based on sales and employee count. First and foremost, we interpret findings for sales
and employee count as supplementary to results for assets, which are not subject to the nondisclosure limitation. The results reported in Section 5 show that the results for sales and
employees support the same main conclusions as the results for assets. More specifically, the
findings in cases where there are substantial numbers of missing observations (for sales and
employee count in some countries) are consistent with findings in cases where there are few
missing observations (for sales and employee count in other countries, and for the assets variable
in all countries).
One factor that contributes to this consistency is that size management to avoid disclosure
is potentially detectable even in countries where small firms are not required to disclose sales or
employee count. Although firms that manage size to remain below the disclosure threshold that
imposes sales and employee count disclosure would obviously not appear in the bin(s) left of the
threshold in the observable sales and employee count distributions, size management would
nonetheless decrease the number of observations in the bin(s) above the threshold, where the
22
observations would have been had the firms not managed size. Thus, for the sales and employee
count variables, size management has an observable effect on the number of observations in the
bins immediately above the threshold even when the effect on the number of observations in the
bins below the threshold is unobservable.
Second, the results reported below are not consistent with simple censoring of the sales
and employee variables below the individual size thresholds. By itself, simple censoring would
lead to negative left standardized differences, as there would be far fewer observations below the
threshold than above. However, the results reported in Section 5 show no significantly negative
left standardized differences. Instead, there are a number of significantly positive left
standardized differences for the sales and employee variables, consistent with size management
and inconsistent with simple censoring due to non-disclosure.
5. Empirical Results
5.1 SIZE MANAGEMENT AT COINCIDING DISCLOSURE AND AUDIT THRESHOLDS
We begin with evidence of size management among firms in four of the largest sample
countries where the small-medium disclosure and audit thresholds coincide. Figure 1 presents the
distributions in the vicinity of the small-medium threshold and the corresponding standardized
differences for Germany, Italy, Spain, and the UK for the full sample period (i.e., for firm-years
with reporting dates ending between January 1, 2003 and December 31, 2011) for total assets
(Panels A–D), sales (Panels E–H), and number of employees (Panels I–L). The small-medium
employee threshold is 50 employees for all four countries for the entire sample period, so the
distributions of number of employees are unscaled. In contrast, as shown in Table 2, the asset
and sales thresholds vary by country and time period for these four countries. Consequently,
23
distributions of assets and sales are presented as a percentage of the country and period-specific
small-medium size threshold.25
Throughout the paper, we examine a large number of standardized differences. Therefore,
to limit the number of significant test statistics expected under the null hypothesis (the level of
significance adopted multiplied by the number of test statistics examined), we adopt a relatively
stringent 1% significance criterion. Standardized difference tests of significance are shown at the
bottom of each panel in Figure 1.
The thrust of the evidence in Figure 1 is that size management is common – a total of six
of the twelve left standardized differences in Figure 1 are significant at the .01 level, including
three of four standardized differences for assets, two of four for employees, and one of four for
sales. The evidence varies by country and threshold variable. For the UK, we find statistically
significant evidence of size management around the asset threshold but no significant evidence
that firms manage sales or employee count. For Germany, we find statistically significant
evidence of asset management, no evidence of sales management, and extremely strong evidence
of employee management.26 For Spain, we find evidence of size management around all three
threshold variables – total assets, sales, and number of employees.27
25
To illustrate, suppose a UK firm reports assets of £2,500,000 for its fiscal year end in 2005. Its asset value is
roughly 10.7% below the small-medium threshold of £2,800,000 for that time period (see Table 2). Thus, this
observation would fall in the bin representing assets between 88% and 90% of the threshold in Figure 1 Panel D. In
a later period when the threshold has risen to £3,260,000, an observation at £2,500,000 in assets would be about
23.4% below the threshold and would fall in the bin between 76% and 78% of the threshold.
26
Panel E of Figure 1 (German sales) is subject to a unique data limitation. Neither small nor medium German
firms are required to report sales, yet in many cases in which firms have not disclosed sales in their filed statements,
Amadeus nevertheless shows sales data. In a suspiciously high proportion of these cases, the Amadeus sales data are
round numbers, suggesting that Amadeus reports approximate sales figures obtained from other sources – in
particular, estimates from national credit bureau offices, such as Creditreform Germany. Since Amadeus does not
include a variable indicating for which observations the database relies on this supplemental information, there is no
reliable way to identify and remove these approximations from the distributions. As an ad hoc solution to this known
data issue, for Panel E (and Panel E alone), we remove observations with values for sales that are round multiples of
€100,000. The resulting distribution is far smoother than that obtained without this selection choice. While this
solution is necessary to avoid false inferences due to a rounding artifact, it also has the unfortunate effect of
removing any true sales values that happen to round to €100,000 and also removes larger sales observations in
slightly greater proportions than smaller sales observations. Thus, although the resulting sales distribution in
24
The significant discontinuities in distributions of employees for Germany and Spain are
subject to an important caveat. German and Spanish laws provide for works councils to represent
employees at the firm level, and the required number of works council members is tied to the
number of employees, which creates another incentive to manage number of employees.28 In
Germany, the works council must be expanded from three to five representatives starting with
the 51st employee. Thus, to the extent adding two more representatives on the works council is
costly to small business owners, some of the discontinuity at 50 employees in Germany may be
due to employers avoiding works council costs, and not strictly costs due to audit or disclosure
requirements.29 In Spain, the works council must be established with the 50th employee, which
makes it more difficult to detect a discontinuity at 50 employees. That is, the discontinuity at 50
employees on the Spanish employees graph (Figure 1 Panel K) exists despite the incentive for
employers to manage the number of employees down to 49 employees to avoid works council
representation for employees.
In contrast to the results for the other three countries, there is no evidence of size
management for Italian firms. The lack of results for Italy is not entirely surprising, as Italy has
Germany does not show evidence of size management, the lack of evidence could be due, at least in part, to the
effects of our selection procedure to deal with this data limitation.
27
Two issues related to taxes also affect the Spanish sales distribution in Figure 1. Spanish firms must file VAT
returns and pay VAT taxes monthly instead of quarterly if their sales in the previous period exceeded €6,010,121.
Additionally, firms with sales exceeding €6,000,000 are monitored by the Spanish Large Taxpayers’ Unit, which
conducts frequent tax audits of firms under its purview (Almunia and Lopez-Rodriguez [2014]). The incentives to
avoid these thresholds manifest themselves in the slight bumps on Figure 1 Panel G between 100 and 110 and 120
and 130 percent of the threshold. When we align the bins relative to either of these two tax thresholds at €6,010,121
or €6,000,000 rather than relative to the disclosure and audit thresholds, we obtain highly significant standardized
differences.
28
In theory, a works council exists to protect the rights of workers as a trade union does, but with additional
powers. For instance, in Germany works councils have the rights of information (that is, to be informed about firm
performance, work place health and safety issues, etc.), consultation (e.g., to be involved in issues regarding the
suspension of staff), and co-determination (e.g., to participate in decisions regarding the employment of workers and
setting a framework for firm compensation practices) (Carley, Welz, and Baradel [2005]; Koller [2010]).
29
While incentives to avoid the expansion of the works council may explain part of the discontinuity at the 50
employee threshold, we consider it unlikely that this is the sole explanation: Although there is a significant
discontinuity at 20 employees (the level at which the works council must be expanded from one to three employees),
it is only half the magnitude of the discontinuity at the 50 employee threshold.
25
arguably the weakest audit requirements of any of the sample countries.30 Unlike in other
European countries, in Italy a private firm can delegate a financial audit to its board of statutory
auditors (Collegio Sindacale). Appointed by shareholders, this internal body is tasked with
monitoring the board of directors and verifying the company’s compliance with certain laws and
statutes (Ferrarini and Giudici [2005]; Melis [2000]). Even when responsible for conducting a
financial audit, members of the board of statutory auditors need not follow legal requirements
concerning independence and often act as tax advisors (Mariani, Tettamanzi, and Corno [2010]).
Thus, the ability to delegate an audit to the board of statutory auditors (as opposed to hiring
external auditors) is likely to make the audit requirement less costly, which attenuates the
incentive for firms to manage size to avoid the audit requirement.
For each variable and country where the standardized difference is significant, Table 5
presents estimates in two forms (range and percentage) of the number of firm-years in which size
management occurred. The range estimate is an estimate of the number of firm-years in which
size management occurred expressed in absolute terms, while the percentage estimate is
expressed as a proportion of the total number of firm-years immediately left of the threshold.
Though we present both range and percentage estimates, we emphasize that the percentage
estimates better describe the economic significance of the results, as the percentages represent
the extent of size management among firms for which the costs of size management are
reasonably low.
Both the range and percentage estimates assume a linear relation among the expected
frequencies in the vicinity of the threshold. More specifically, the estimates assume that the
30
It is also possible that the lack of results in Italy could be due to a lack of enforcement of disclosure and audit
requirements. Enforcement is a necessary condition for either audit or disclosure requirements to be costly to a firm,
and Italy scores among the worst of European countries on measures of the pervasiveness of corruption, efficiency
of the legal system, and the quality of legal enforcement (Burgstahler, Hail, and Leuz [2006]; La Porta et al. [1998]).
However, if disclosure requirements are unenforced, then the data availability for Italy (as shown in Tables 3 and 4)
should be relatively poor. Instead, we find the data availability for Italy is relatively good.
26
expected frequencies for the two bins above and the two bins below the threshold can be
estimated based on the observed frequencies in the bins third closest to the threshold.31
For each range estimate, one side of the range is calculated by summing the deviations
from the expected linear relationship in the two bins immediately left of the threshold (“how
many more observations are in these bins than would be expected in the absence of size
management incentives”). The other side of the range is calculated by summing the deviations
from the expected linear relationship in the two bins immediately right of the threshold (“how
many fewer observations are in these bins than would otherwise be expected”). When we
average the two sides of each range estimate and sum the resulting averages across variables and
countries, we estimate the frequency of size management at 4,375 firm-years. However, this
estimate likely understates the overall number of firm-years in these four countries affected by
size management as Amadeus’ data coverage is limited for the first several years of our sample
period (see Table 3 Panel B).
Whereas the range estimate incorporates estimates of the number of observations
managed to values below the threshold and the number managed from above the threshold, the
percentage of firm-years managed is based solely on the estimate of the number managed to
values below the threshold. The percentage estimate of firm-years managed is the difference
between the actual number of observations in the bin immediately left of the threshold and the
expected number based on the expected linear relationship between the bins third closest to the
threshold, expressed as a percentage of the actual number of observations in the bin immediately
31
The assumptions underlying these estimates are that (1) the bins third closest to the threshold (on either side)
in the observable distributions are not affected by size management, and (2) that in the absence of size management
incentives, the numbers of observations in the two bins immediately below and two bins immediately above the
threshold would be equal to the linear interpolation of the numbers in the bins third closest to the threshold. The
range estimates include the effects on the two bins on each side of the threshold (rather than just a single bin on each
side) because visual inspection suggests that although the majority of the estimated number of observations appear
to be managed to and from one bin on either side of the threshold, size management sometimes also affects the
second bin on either side.
27
left of the threshold. For the assets variable, the estimated percentages of firm-years managed are
20.8% for the UK, 12.0% for Germany, and 2.6% for Spain. For the sales and employee
variables, the estimates range from 5.7% to 42.6%, where the largest estimated percentage is for
the employee variable among German firms.
Table 6 Panel A summarizes the results of standardized difference tests for all the sample
countries where thresholds coincide for at least some portion of the sample period. In addition to
the four countries discussed in Figure 1, Table 6 Panel A includes standardized difference test
statistics for coinciding thresholds in Austria, Belgium, Ireland, and the Netherlands. For these
four additional countries, we test only six of the twelve size variable distributions, because in the
remaining six cases either (1) the average number of observations in the bins used for the
standardized difference statistic is less than 100 (i.e., the test would have low power), or (2) there
is evidence that the Amadeus data relies on rounded estimates from national credit bureaus that
invalidate the assumption of a smooth distribution even in the absence of size management. We
find significant evidence of size management at the total assets threshold in Austria, but no
significant evidence at the remaining size thresholds.
5.2 SIZE MANAGEMENT AT SEPARATE DISCLOSURE AND AUDIT THRESHOLDS
Because the disclosure and audit size thresholds coincide for the countries and time
periods discussed above, the evidence of size management thus far could be attributable either to
size management to avoid disclosure costs or to size management to avoid audit costs. In this
section, we attempt to separate the effects of these two incentives by examining evidence of size
management for cases where disclosure and audit thresholds do not coincide.32
32
In principle, an alternative approach to disentangle size management incentives at coinciding thresholds would
be to examine size management for the subsample of firms that have already chosen to have an audit for other
reasons and thus have no incentive to manage size to avoid audit costs. Unfortunately, data limitations prevent us
from pursuing this approach because Amadeus includes only the audit status of a given firm in the most recent year
for which Amadeus has data, but not for any earlier years.
28
5.2.1. Evidence of Size Management at Separate Disclosure Thresholds
Table 6 Panel B presents the standardized differences from tests of size management at
disclosure thresholds that do not coincide with audit thresholds. Figure 2 provides corresponding
graphical evidence of size management of total assets for four of these countries: France,
Sweden, Denmark, and Ireland. We plot and discuss asset distributions for these four countries
because (1) the four countries represent a variety of incremental disclosure requirements, as
discussed further below, and (2) they have relatively large sample sizes due to high levels of data
coverage.
Figure 2 Panel A presents evidence of French firms’ management of total assets to avoid
expanded balance sheet, income statement, notes, and director’s report disclosure. We find no
evidence that firms manage size to avoid these disclosures (standardized difference = -0.24).
Because firms classified as small in France are required to disclose sales, we also have
essentially complete data coverage for the sales variable. Although we do not plot the
distribution of sales, Table 6 Panel B shows that the standardized difference at the sales threshold
in France is 1.78, again providing no significant evidence that firms are willing to incur costs to
avoid competitive costs arising from these additional disclosures.
In Figure 2 Panel B we plot evidence of size management of assets by Swedish firms to
avoid expanded balance sheet, income statement, cash flow statement, notes, and director’s
report disclosure. In Sweden, small firms can choose to, among other things, withhold cash flow
statement disclosure and abbreviate income statement information to avoid disclosing detail on
components of gross profit under the cost of expenditure format of income statement reporting
(see Appendix 1). Here again we find no significant evidence that firms manage assets to avoid
these disclosures (standardized difference = 0.43). There is high data coverage for the sales and
employee count variables in Sweden, yet there is no significant evidence of size management in
29
Table 6 Panel B for either sales (standardized difference = -0.03) or number of employees
(standardized difference = 0.88).33
Figure 2 Panel C provides evidence of size management of assets by Danish firms. Like
French and Swedish firms, Danish firms that exceed the small-medium disclosure threshold are
required to present expanded balance sheet, notes, and director’s report disclosure. Unlike
French and Swedish firms, however, Danish firms classified as small have the option to report
abbreviated income statement information without separately disclosing sales and cost of goods
sold. Instead, small firms in Denmark can begin income statements with gross profit, while
medium-sized firms must begin their income statements with sales. Consistent with Dedman and
Lennox [2009], who examine a similar exemption available to medium-sized UK firms prior to
2009, we find that large numbers of small Danish firms choose to not disclose sales information
(see the data coverage statistics in Table 4). However, as shown in Figure 2 Panel C, we find no
significant evidence that firms manage size to avoid sales and cost of goods sold disclosure, in
addition to expanded balance sheet, notes, and director’s report disclosures (standardized
difference = 0.50).34
Finally, Figure 2 Panel D presents evidence of management of total assets among Irish
firms. Whereas small firms in Ireland are only required to disclose an abbreviated balance sheet
and limited notes, medium firms are required to disclose an abbreviated income statement, an
expanded balance sheet, additional notes information, and a director’s report. This expansion of
disclosure at the small-medium threshold is virtually identical to that in Germany and the UK,
33
The implication that cash flow statement disclosure does not impose substantial proprietary costs of disclosure
is reinforced by the similar lack of results in Table 6 Panel B for Finland, where cash flow statement disclosure is
required for firms above the small-medium size thresholds but not for those below.
34
The expanded disclosure requirements in Denmark are nearly identical to those in Belgium. The high number
of missing values for sales for Belgium firm observations is consistent with the idea that small Belgian firms, like
Danish firms, prefer to not disclose sales and cost of goods sold information. Though the disclosure and audit
thresholds coincide for our sample period in Belgium, we note that there is little evidence of size management to
avoid disclosure and audit costs for Belgium (see Table 6 Panel A). From this perspective, the evidence from the
Belgian setting is consistent with the findings for Denmark.
30
where there is substantial evidence of size management at coinciding disclosure and audit
thresholds. However, in contrast to Germany and the UK, the standardized difference (2.02) at
the total assets disclosure threshold is not significant at the .01 level, thus providing little or no
evidence that small firms manage size to avoid disclosing income statements in their entirety.
Taken collectively, evidence of size management at separate disclosure thresholds
provides no significant support for the hypothesis (H1) that firms incur costs solely to avoid
proprietary costs of additional disclosure. None of the ten standardized differences in Table 6
Panel B are significant. Thus, evidence of size management at separate disclosure thresholds
provides no support for the conjecture that extensive evidence of size management at coinciding
disclosure and audit thresholds is driven primarily by incentives to avoid disclosure
requirements.
5.2.2. Evidence of Size Management at Separate Audit Thresholds
Table 6 Panel C presents the standardized differences from tests of size management at
audit thresholds that do not coincide with disclosure thresholds. Each of these four thresholds
corresponds to a disclosure threshold we examine in Table 6 Panel B. That is, since the audit
thresholds and disclosure thresholds are based on the same size variables, we can examine
evidence of size management at different levels of the same underlying size variable
distributions that we examine in Section 5.2.1.35 In Figure 3, we present corresponding graphical
evidence of size management for each of these separate audit thresholds.
35
As discussed in Section 2 and Table 2, during most of our sample period all limited liability firms were subject
to an audit requirement in the Scandinavian countries. Even after small firms were exempted later in the sample
period, the size thresholds were set extremely low relative to those in other European countries. For example, the
thresholds for number of employees in Denmark, Finland, and Sweden were 12, 3, and 3, respectively. Because
maintaining size below these extremely low thresholds to avoid the audit requirement is likely to be very costly, and
because there are only a limited number of observations during the period when firms could have been exempted
from the audit requirement, we would not expect significant evidence of size management to avoid an audit.
Therefore, tests of significance are not shown in Panel C for these countries.
31
Overall, the evidence in Table 6 Panel C and Figure 3 strongly supports the hypothesis
(H2) that European firms manage size to avoid mandatory audits. Each of the four standardized
differences is significant at the .01 level. The most significant evidence of size management to
avoid audit requirements is for sales of UK firms in the early 2000s, a setting that provides a
particularly powerful test of the audit hypothesis. Table 2 shows that regulators typically set the
sales threshold to be approximately twice that of the assets threshold, but in the case of UK
firms’ sales in 2003 and early 2004, the sales threshold was much lower, at just 71% of the assets
threshold. As a result, it is likely that during this period a much higher proportion of UK firms
had an incentive to manage sales to avoid mandatory audit requirements (that is, the sales
threshold was most likely to be “binding”). The distribution shown in Panel A of Figure 3 and
the standardized difference in Panel C of Table 6 provide strong evidence of management of
sales by UK firms during this period.
5.2.3. Summary of Findings
We find clear evidence of size management to remain below separate audit thresholds,
but no significant evidence of size management to remain below separate disclosure thresholds.
There are two important implications of these findings. First, the evidence of size management to
remain below coinciding disclosure and audit thresholds in Section 5.1 is more likely to be
attributable to audit costs than to disclosure costs. Second, these results suggest that proprietary
costs of disclosure are typically lower than net audit costs. Because net audit costs are likely to
be relatively low for the small private firms in our sample, the findings provide essentially no
support for the proposition that mandated disclosure of financial statement information imposes
economically significant proprietary costs.
32
6. Conclusion
This paper provides evidence of size management to minimize disclosure costs and audit
costs among small private firms in Europe. Proprietary costs of disclosure should be relatively
important for small firms, for which financial statements likely reveal information about
activities concentrated in a single market, and for private firms, for which competitors have
limited access to other (non-financial statement) information sources. The empirical tests focus
on size management by firms where premanaged size variables likely exceed bright-line
thresholds by only a few percent and the corresponding cost of size management should be
relatively low. In this setting where incentives to manage size should be relatively strong, we
find no significant evidence that firms incur costs solely to avoid expanded financial statement
disclosure requirements. At the same time, we find substantial evidence that firms incur similar
costs to avoid a required audit, even though the net cost imposed by an audit is likely to be
relatively low. Together, these findings suggest that proprietary costs of disclosure are typically
less than net audit costs. Thus, in a setting where proprietary costs should be relatively important,
we find essentially no support for the proposition that mandated disclosure of financial statement
information imposes economically significant proprietary costs.
The results of our study have several important implications. First, the findings reinforce
Berger’s [2011] call for researchers to control for agency and other costs of disclosure in tests of
proprietary disclosure costs. We find no significant evidence that firms manage size to avoid
proprietary costs due to financial statement disclosure, even in cases where the expanded
disclosures are identical to or more substantial than those studied in prior literature (e.g.,
Dedman and Lennox [2009]). These findings suggest that managers may prefer less disclosure at
the margin but are unwilling to incur the costs of size management to avoid expanded disclosure.
However, we caution that we do not provide evidence on every possible expansion of financial
33
statement disclosure, e.g., there is no setting in Europe that allows us to study whether firms
manage size to entirely avoid balance sheet disclosure.
Second, the results are likely to be of interest to national regulators. Evidence that firms
manage size to avoid mandatory audit requirements is consistent with (1) concerns among
European policymakers about the costs of certain regulatory requirements imposed on small
firms (European Commission [2010]) and (2) evidence in other areas that certain “bright-line”
size thresholds give firms an incentive to “stay small” (Gao, Wu, and Zimmerman [2009]). The
results also show that the magnitude and method of size management varies substantially by
country. National regulators have historically set the sales and assets thresholds at a ratio of
roughly 2:1, and have left unchanged for more than a decade the small-medium employee
threshold. These regulation decisions may partially determine which thresholds are binding in
each jurisdiction, and thus dictate which variables are managed. More broadly, then, the analysis
suggests that uniform regulation could have different economic consequences across European
countries – an implication that should be considered as European regulators contemplate
harmonizing size thresholds across Europe (European Commission [2011]).
34
Appendix 1: Disclosure Requirements for European Private Firms
This table summarizes the disclosure requirements for private European limited liability firms below and above the smallmedium disclosure threshold.
Below disclosure threshold:
Above disclosure threshold:
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Expanded abbreviated format
Firms are required to report subcategories of some
balance sheet items (e.g., trade receivables, trade
payables).
Income
Statement
No disclosure requirement
Abbreviated format
Firms can aggregate certain items (e.g., sales, increase
or decrease in finished goods, own work capitalized,
cost of materials) to gross profit.
Other
disclosures
Abbreviated notes
Expanded abbreviated notes; director's report
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of inventories (e.g., raw materials,
work in progress).
Full format
No option to aggregate items
Income
Statement
Abbreviated format
Firms can aggregate certain items (e.g., sales, cost of materials) to
gross profit. Information on items such as increase or decrease in
finished goods and own work capitalized can be omitted.
Full format
No option to aggregate items
Other
disclosures
Abbreviated notes
Full notes; director's report
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Full format
No option to aggregate items
Income
Statement
Abbreviated format
Firms can aggregate certain items (e.g., sales, cost of sales, other
operating income) to gross profit.
Full format
No option to aggregate items
Other
disclosures
Abbreviated notes
Full notes; director's report
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Full format
No option to aggregate items
Income
Statement
Full format
No option to aggregate items
Full format
No option to aggregate items
Other
disclosures
Expanded abbreviated notes
Full notes; cash flow statement; director's report
Austria
Belgium
Denmark
Finland
35
France
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Full format
No option to aggregate items
Income
Statement
Abbreviated format
Firms can withhold information about few items (e.g., income from
long term transactions or cost of materials).
Full format
No option to aggregate items
Other
disclosures
Abbreviated notes
Full notes; director's report
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Expanded abbreviated format
Firms are required to report subcategories of some
balance sheet items (e.g., trade receivables, trade
payables).
Income
Statement
No disclosure requirement
Abbreviated format
Firms can aggregate certain items (e.g., sales, increase
or decrease in finished goods, own work capitalized,
other operating income, cost of materials) to gross
profit.
Other
disclosures
Abbreviated notes
Expanded abbreviated notes; director's report
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Full format
No option to aggregate items
Income
Statement
No disclosure requirement
Abbreviated format
Firms can aggregate certain items (e.g., sales, cost of
sales, other operating income) to gross profit.
Other
disclosures
Abbreviated notes
Expanded abbreviated notes; director's report
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet.
For instance, an abbreviated balance sheet does not provide
information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill) or inventories (e.g., raw
materials, work in progress), and does not separately disclose
current and long-term liabilities.
Full format
No option to aggregate items
Income
Statement
Abbreviated format
Firms can aggregate certain items (e.g., increase or decrease in
finished goods, increase or decrease of contract work capitalized).
Full format
No option to aggregate items
Other
disclosures
Abbreviated notes
Full notes; director's report
Germany
Balance Sheet
Ireland
Italy
36
Netherlands
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet. For
instance, an abbreviated balance sheet does not provide information
on components of intangible assets (e.g., self-developed intangible
assets, goodwill) or inventories (e.g., raw materials, work in
progress), and does not separately disclose current and long-term
liabilities.
Expanded abbreviated format
Firms are required to report subcategories of some
balance sheet items (e.g., trade receivables, trade
payables).
Income
Statement
No disclosure requirement
Abbreviated format
Firms can aggregate certain items (e.g., sales, increase
or decrease in finished goods, own work capitalized,
other operating income, cost of materials) to gross
profit.
Other
disclosures
Abbreviated notes
Expanded abbreviated notes; director's report
Balance Sheet
Abbreviated format
Before 2008, firms could aggregate subcategories of items on the
balance sheet. For instance, an abbreviated balance sheet did not
provide information on components of intangible assets (e.g., selfdeveloped intangible assets, goodwill). Since 2008, firms are
required to report subcategories of some items (e.g., trade
receivables, trade payables).
Full format
No option to aggregate items
Income
Statement
Abbreviated format
Firms can withhold information about few subcategories of items
(e.g., other operating expenses).
Abbreviated format
Firms can withhold information about few subcategories
of items (e.g., other operating expenses).
Other
disclosures
Abbreviated notes; abbreviated statement of equity changes
Expanded abbreviated notes; cash flow statement;
director's report; statement of equity changes
Balance Sheet
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet. For
instance, an abbreviated balance sheet does not provide information
on components of intangible assets (e.g., self-developed intangible
assets, goodwill) or inventories (e.g., raw materials, work in
progress), and does not separately disclose current and long-term
liabilities.
Full format
No option to aggregate items
Income
Statement
Abbreviated format
Firms can aggregate certain items (e.g., increase or decrease in
finished goods, own work capitalized, other operating income, cost
of materials) to gross profit.
Full format
No option to aggregate items
Other
disclosures
Abbreviated notes
Full notes; cash flow statement; director's report
Abbreviated format
Firms can aggregate subcategories of items on the balance sheet. For
instance, an abbreviated balance sheet does not provide information
on components of intangible assets (e.g., self-developed intangible
assets, goodwill) or inventories (e.g., raw materials, work in
progress), and does not separately disclose current and long-term
liabilities.
Full format
No option to aggregate items
Income
Statement
No disclosure requirement
Abbreviated format
Before 2009, medium-sized firms could aggregate
certain items (e.g., sales, cost of sales, other operating
income) to gross profit. Since 2009, firms are required
to report sales information.
Other
disclosures
Abbreviated notes
Expanded abbreviated notes; director's report
Balance Sheet
Spain
Sweden
United Kingdom
Balance Sheet
37
Appendix 2: Audit Requirements for European Private Firms
This table summarizes the audit requirements for private European limited liability firms below and above the small-medium
audit threshold.
Below audit threshold:
Above audit threshold:
Austria
No mandatory audit
Mandatory audit by certified auditors or certified accountants;
while non-audit services (e.g., tax consulting, legal services) are
allowed, bookkeeping services are prohibited.
Belgium
No mandatory audit
Mandatory audit by certified auditors; while non-audit services
(e.g., tax consulting, legal services) are allowed, bookkeeping
services are prohibited.
Denmark
Before 2006, all limited liability firms
regardless of size had to be audited; since
2006, firms below the threshold are exempt
from mandatory audit requirements.
Mandatory audit by certified auditors or certified accountants;
non-audit services are allowed (e.g., tax consulting, legal
services). In certain circumstances, auditors can also provide
bookkeeping services to audit clients.
Finland
Before 2008, all limited liability firms
regardless of size had to be audited; since
2008, firms below the threshold are exempt
from mandatory audit requirements.
Mandatory audit by certified auditors or non-certified auditors;
auditors may provide non-audit services (e.g., tax consulting, legal
services) subject to independence requirements. Bookkeeping
services are not allowed.
France
No mandatory audit
Mandatory audit by certified auditors. Non-audit services are
generally not allowed.
Germany
No mandatory audit
Mandatory audit by certified auditors or certified accountants;
while non-audit services (e.g., tax consulting, legal services) are
allowed, bookkeeping services are prohibited.
No mandatory audit
Mandatory audit by chartered accountants or certified
accountants; non-audit services are allowed (e.g., tax consulting,
legal services). In certain circumstances, auditors can also provide
bookkeeping services to audit clients.
No mandatory audit
Mandatory audit by firms' internal board of auditors (Collegio
Sindacale) or certified auditors; internal board of auditors may
provide administrative audit and non-audit services (e.g., tax
consulting, legal services).
Netherlands
No mandatory audit
Mandatory audit by certified auditors or certified accountants;
non-audit services are allowed (e.g., tax consulting, legal
services). In certain circumstances, auditors can also provide
bookkeeping services to audit clients.
Spain
No mandatory audit
Mandatory audit by certified auditors or certified accountants;
while non-audit services (e.g., tax consulting, legal services) are
allowed, bookkeeping services are prohibited.
Sweden
Before 2011, all limited liability firms
regardless of size had to be audited; since
2011, firms below the threshold are exempt
from mandatory audit requirements.
Mandatory audit by certified auditors or certified accountants;
non-audit services are allowed (e.g., tax consulting, legal
services). In certain circumstances, auditors can also provide
bookkeeping services to audit clients.
No mandatory audit
Mandatory audit by chartered accountants or certified
accountants; non-audit services are allowed (e.g., tax consulting,
legal services). In certain circumstances, auditors can also provide
bookkeeping services to audit clients.
Ireland
Italy
United
Kingdom
38
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Figure 1: Total Asset, Sales, and Employee Distributions at Coinciding Thresholds
This figure presents distributions of total assets (Panels A-D), sales (Panels E-H), and employee count (Panels I-L) for private limited liability firms in Germany (“DE”), Italy
(“IT”), Spain (“ES”), and the UK in time periods when the disclosure and audit thresholds coincide. Superimposed vertical lines are drawn to demarcate the size threshold between
small and medium classification. The standardized difference (SD) statistics are the left standardized difference test statistics as defined in Burgstahler and Chuk [2014].
Standardized difference statistics significant at the 1% level (one-tailed) are noted with a † superscript. Bin size is 2% of the threshold value in all panels.
C: Distribution of Total Assets for ES Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
Reporting dates Jan 1 2003 through Dec 31 2011
2000
5000
Frequency
10000 15000
Frequency
4000 6000 8000
20000
10000
25000
A: Distribution of Total Assets for DE Private Firms
60
70
80
90
100
110
Percentage of Threshold
120
130
140
60
SD sta s c = 8.16†
70
80
90
100
110
Percentage of Threshold
120
130
140
SD sta s c = 3.29†
Reporting dates Jan 1 2003 through Dec 31 2011
5000
5000
Frequency
10000 15000
Frequency
10000
15000
20000
20000
D: Distribution of Total Assets for UK Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
25000
B: Distribution of Total Assets for IT Private Firms
60
70
80
90
100
110
Percentage of Threshold
120
130
140
60
SD statistic = 0.28
70
80
90
100
110
Percentage of Threshold
120
130
140
SD sta s c = 21.93†
41
Figure 1 (cont): Total Asset, Sales, and Employee Distributions at Coinciding Thresholds
Panel F (German sales) is adjusted for rounded data estimates from Creditreform Germany (see footnote 26).
G: Distribution of Sales for ES Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
Reporting dates Jan 1 2003 through Dec 31 2011
0
500
Frequency
5000
Frequency
1000
1500
2000
2500
10000
E: Distribution of Sales for DE Private Firms
60
70
80
90
100
110
Percentage of Threshold
120
130
140
60
SD statistic = 1.49
70
80
90
100
110
Percentage of Threshold
120
130
140
SD sta s c = 8.69†
H: Distribution of Sales for UK Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
Reporting dates Mar 30 2004 through Dec 31 2011
1000
Frequency
5000
Frequency
2000
10000
3000
F: Distribution of Sales for IT Private Firms
60
70
SD statistic = 2.27
80
90
100
110
Percentage of Threshold
120
130
140
60
70
80
90
100
110
Percentage of Threshold
120
130
140
SD statistic = 1.69
42
Figure 1 (cont): Total Asset, Sales, and Employee Distributions at Coinciding Thresholds
Reporting dates Jan 1 2003 through Dec 31 2011
8000
Frequency
4000
6000
0
500
2000
Frequency
1000
1500
2000
10000
K: Distribution of Employee Count for ES Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
2500
I: Distribution of Employee Count for DE Private Firms
30
35
40
45
50
Employees
55
60
65
70
30
SD sta s c = 25.48†
35
40
45
50
Employees
55
60
65
70
SD sta s c = 3.76†
L: Distribution of Employee Count for UK Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
Reporting dates Jan 1 2003 through Dec 31 2011
0
0
1000
1000
Frequency
2000
3000
Frequency
2000
4000
5000
3000
J: Distribution of Employee Count for IT Private Firms
30
35
SD statistic = ‐0.85
40
45
50
Employees
55
60
65
70
30
35
40
45
50
Employees
55
60
65
70
SD statistic = 1.35
43
Figure 2: Selected Disclosure Thresholds That Do Not Coincide with Audit Thresholds
This figure presents distributions of total assets for private limited liability firms around disclosure thresholds in countries (France, “FR”; Sweden, “SE”; Denmark, “DK”; and Ireland,
“IE”) and time periods when the disclosure thresholds do not coincide with the audit thresholds. Superimposed vertical lines are drawn to demarcate the small-medium size disclosure
threshold. The standardized difference (SD) statistics are the left standardized difference test statistics as defined in Burgstahler and Chuk [2014]. Standardized difference statistics
significant at the 1% level (one-tailed) are noted with a † superscript. Bin size is 2% of the threshold value.
Panel C: Distribution of Total Assets for DK Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
Reporting dates Jan 1 2003 through Dec 31 2011
10000
400
Frequency
800
Frequency
20000
30000
1200
40000
Panel A: Distribution of Total Assets for FR Private Firms
60
70
80
90
100
110
120
Percentage of Disclosure Threshold
130
140
60
SD statistic = ‐0.24
70
80
90
100
110
120
Percentage of Disclosure Threshold
130
Panel D: Distribution of Total Assets for IE Private Firms
Reporting dates Jan 1 2003 through Dec 31 2011
Reporting dates Feb 24 2007 through Dec 31 2011
0
0
1000
500
Frequency
2000
3000
Frequency
1000
4000
1500
Panel B: Distribution of Total Assets for SE Private Firms
5000
140
SD statistic = 0.50
60
70
SD statistic = 0.43
80
90
100
110
120
Percentage of Disclosure Threshold
130
140
60
70
80
90
100
110
120
Percentage of Disclosure Threshold
130
140
SD statistic = 2.02
44
Figure 3: Selected Audit Thresholds That Do Not Coincide with Disclosure Thresholds
This figure presents distributions of sales and total assets for private limited liability firms around audit thresholds in countries (UK; Ireland, “IE”; France, “FR”) and time periods when
the audit thresholds do not coincide with the disclosure thresholds. Superimposed vertical lines are drawn to demarcate the small-medium size audit threshold. The standardized
difference (SD) statistics are the left standardized difference test statistics as defined in Burgstahler and Chuk [2014]. Standardized difference statistics significant at the 1% level (onetailed) are noted with a † superscript. Bin size is 2% of the threshold value.
Panel C: Distribution of Total Assets for FR Private Firms
Reporting dates Jan 01 2003 through Mar 29 2004
Reporting dates Jan 1 2003 through Dec 31 2011
0
200
5000
Frequency
10000
Frequency
400
600
15000
800
20000
Panel A: Distribution of Sales for UK Private Firms
60
70
80
90
100
110
Percentage of Audit Threshold
120
130
140
60
SD sta s c = 10.37†
70
80
90
100
110
Percentage of Audit Threshold
120
130
140
SD sta s c = 5.75†
Panel D: Distribution of Sales for FR Private Firms
Reporting dates Feb 24 2007 through Dec 31 2011
Reporting dates Jan 01 2003 through Dec 31 2011
0
200
5000
Frequency
400
600
Frequency
10000
800
1000
15000
Panel B: Distribution of Total Assets for IE Private Firms
60
70
SD sta s c = 2.58†
80
90
100
110
Percentage of Audit Threshold
120
130
140
60
70
80
90
100
110
Percentage of Audit Threshold
120
130
140
SD sta s c = 3.34†
45
Table 1: Disclosure Requirements for European Private Firms
This table summarizes the disclosure requirements for private European limited liability firms below and above the smallmedium disclosure threshold. Abbreviated format disclosures, expanded abbreviated format disclosures, and full format
disclosures are differentiated by the level of detail each presents. Countries noted with a * have other disclosure requirements
beyond those summarized below; see Appendix 1 for a more complete description of disclosure requirements by country.
Austria
Balance Sheet
Income Statement
Other disclosures
Below disclosure threshold:
Abbreviated format
No disclosure requirement
Abbreviated notes
Above disclosure threshold:
Expanded abbreviated format
Abbreviated format
Expanded abbreviated notes; director's report
Belgium
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Abbreviated format
Abbreviated notes
Full format
Full format
Notes; director's report
Denmark
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Abbreviated format
Abbreviated notes
Full format
Full format
Notes; director's report
Finland*
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Full format
Expanded abbreviated notes
Full format
Full format
Notes; director's report
France
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Abbreviated format
Abbreviated notes
Full format
Full format
Notes; director's report
Germany
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
No disclosure requirement
Abbreviated notes
Expanded abbreviated format
Abbreviated format
Expanded abbreviated notes; director's report
Ireland
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
No disclosure requirement
Abbreviated notes
Full format
Abbreviated format
Expanded abbreviated notes; director's report
Italy
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Abbreviated format
Abbreviated notes
Full format
Full format
Notes; director's report
Netherlands
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
No disclosure requirement
Abbreviated notes
Expanded abbreviated format
Abbreviated format
Expanded abbreviated notes; director's report
Spain*
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Abbreviated format
Abbreviated notes
Full format
Abbreviated format
Expanded abbreviated notes; director's report
Sweden*
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
Abbreviated format
Abbreviated notes
Full format
Full format
Notes; director's report
United
Kingdom
Balance Sheet
Income Statement
Other disclosures
Abbreviated format
No disclosure requirement
Abbreviated notes
Full format
Abbreviated format
Expanded abbreviated notes; director's report
46
Table 2: Size Classification Thresholds by Country and Time Period
This table summarizes the small-medium size thresholds for the twelve sample countries by time period. We hand collect
threshold information from national laws. The dates listed below are for firms’ reporting end dates. The number of employees
refers to the average number of persons employed by the company during the fiscal year. Audit threshold amounts that do not
coincide with disclosure thresholds are bolded and italicized. Total assets and sales amounts are stated in euro for all countries
except Denmark, Sweden, and the UK, where total assets and sales amounts are stated in Danish krone, Swedish krona, and
British pounds, respectively. Total assets and sales disclosure and audit thresholds effective in the early 2000s are translated from
pre-euro currency for Spain and Ireland. Our subsequent tests of size management do not include the audit thresholds for
Denmark, Finland, and Sweden (highlighted in gray), as small firms did not become exempt from audit requirements in these
countries until late in our sample period.
Austria
Panel A: Disclosure Thresholds
Since:
Total assets
Sales
Jan 1, 2003
3,125,000
6,250,000
Dec 31, 2005
3,650,000
7,300,000
Dec 31, 2008
4,840,000
9,680,000
Employees
50
50
50
Belgium
Jan 1, 2003
Dec 31, 2004
3,125,000
3,650,000
6,250,000
7,300,000
50
50
Denmark
Jan 1, 2003
Mar 31, 2005
Aug 31, 2009
20,000,000
29,000,000
36,000,000
40,000,000
58,000,000
72,000,000
50
50
50
Finland
Jan 1, 2003
Dec 31, 2005
3,125,000
3,650,000
6,250,000
7,300,000
50
50
France
Jan 1, 2003
Dec 31, 2010
267,000
1,000,000
534,000
2,000,000
10
20
Germany
Jan 1, 2003
Dec 31, 2004
Dec 31, 2009
3,438,000
4,015,000
4,840,000
6,875,000
8,030,000
9,680,000
50
50
50
Jan 1, 2003
1,904,607
3,809,214
50
Italy
Jan 1, 2003
Dec 12, 2006
Nov 21, 2009
3,125,000
3,650,000
4,400,000
6,250,000
7,300,000
8,800,000
50
50
50
Netherlands
Jan 1, 2003
Dec 31, 2004
Dec 31, 2006
3,500,000
3,650,000
4,400,000
7,000,000
7,300,000
8,800,000
50
50
50
Spain
Jan 1, 2003
Dec 31, 2008
2,373,998
2,850,000
4,747,996
5,700,000
50
50
Sweden
Jan 1, 2003
Oct 31, 2011
29,000,000
40,000,000
58,000,000
80,000,000
50
50
United
Kingdom
Jan 1, 2003
Jan 30, 2004
Apr 5, 2009
1,400,000
2,800,000
3,260,000
2,800,000
5,600,000
6,500,000
50
50
50
Jun 30, 2008
Jan 1, 2003
Jan 1, 2003
Dec 31, 2004
Dec 31, 2009
Ireland
Jan 1, 2003
Mar 30, 2004
Apr 5, 2009
6,250,000
7,300,000
3,000,000
8,000,000
50
50
50
7,000,000
7,300,000
8,800,000
2,373,998
2,850,000
50
50
50
4,747,996
5,700,000
1,500,000
50
50
3,000,000
1,400,000
2,800,000
3,260,000
50
50
50
6,250,000
7,300,000
8,800,000
3,500,000
3,650,000
4,400,000
50
50
50
317,434
1,500,000
7,300,000
3,125,000
3,650,000
4,400,000
50
6,875,000
8,030,000
9,680,000
1,904,607
1,904,607
3,650,000
3
3,100,000
3,438,000
4,015,000
4,840,000
Employees
50
50
50
50
50
12
12
200,000
1,550,000
Jan 1, 2003
Dec 31, 2008
Oct 31, 2011
Sales
6,250,000
7,300,000
9,680,000
100,000
Jan 1, 2003
Jun 30, 2005
Feb 24, 2007
Jan 1, 2003
Dec 12, 2006
Nov 21, 2009
Jan 1, 2003
Dec 31, 2004
Dec 31, 2006
Panel B: Audit Thresholds
Since:
Total assets
Jan 1, 2003
3,125,000
Dec 31, 2005
3,650,000
Dec 31, 2008
4,840,000
Jan 1, 2003
3,125,000
Dec 31, 2004
3,650,000
Dec 31, 2006
1,500,000
Dec 31, 2011
4,000,000
3
1,000,000
5,600,000
6,500,000
50
50
50
47
Table 3: Sample Selection Procedure
This table summarizes the steps of the sample selection process (Panel A), the breakdown of observations by year (Panel B), and the number of observations close to the total assets
disclosure threshold (Panel C).
Panel A: Sample Selection
Austria
Belgium
Denmark
Finland
France
Germany
Ireland
Italy
Netherlands
Spain
Sweden
United
Kingdom
Total
Single account firm-year
observations within the
sample period
679,782
2,794,715
824,553
957,658
6,947,687
5,780,829
843,775
5,939,260
4,051,965
5,380,630
2,066,215
10,362,042
46,629,111
Less: public firms and
firms in finance, insurance,
and public administration
(15,695)
(49,969)
(70,829)
(42,495)
(300,991)
(110,806)
(38,905)
(73,671)
(396,795)
(53,966)
(51,679)
(232,556)
(1,438,357)
Less: non-limited
liability firms and firms
using IFRS
(51,963)
(1,292,241)
(172,286)
(15,016)
(2,321,330)
(971,865)
(267,213)
(1,552,027)
(28,207)
(649,985)
(7)
(630,775)
(7,952,915)
Total observations
612,124
1,452,505
581,438
900,147
4,325,366
4,698,158
537,657
4,313,562
3,626,963
4,676,679
2,014,529
9,498,711
37,237,839
Austria
Belgium
Denmark
Finland
France
Germany
Ireland
Italy
Netherlands
Spain
Sweden
United
Kingdom
Total
2003
1,881
107,912
0
63,051
310,917
32,748
41,890
129,456
192,866
376,078
153,854
587,720
1,998,373
2004
29,412
118,298
0
67,504
345,703
58,389
45,909
294,888
216,029
399,731
164,730
717,635
2,458,228
2005
39,148
129,733
0
71,461
384,488
370,164
50,177
321,210
302,731
435,786
177,742
807,934
3,090,574
2006
67,939
143,165
0
73,805
431,891
603,779
56,243
358,411
395,006
487,564
196,609
909,190
3,723,602
2007
83,077
158,587
39,268
98,320
484,782
642,159
61,974
562,936
439,051
469,976
217,624
1,028,119
4,285,873
2008
90,844
176,165
117,616
118,015
544,515
715,305
67,621
619,885
483,484
591,794
241,915
1,180,881
4,948,040
2009
92,841
194,004
133,471
127,403
587,404
775,167
71,992
676,325
521,013
671,054
268,196
1,315,204
5,434,074
2010
97,258
206,794
142,259
139,574
619,963
766,845
72,226
687,635
540,460
664,677
282,999
1,440,233
5,660,923
109,724
217,847
148,824
141,014
615,703
733,602
69,625
662,816
536,323
580,019
310,860
1,511,795
5,638,152
612,124
1,452,505
581,438
900,147
4,325,366
4,698,158
537,657
4,313,562
3,626,963
4,676,679
2,014,529
9,498,711
37,237,839
Panel B: Observations by Year
2011
Total observations
Panel C: Observations Close to Total Assets Disclosure Threshold
Austria
Belgium
Denmark
Finland
France
Germany
Ireland
Italy
Netherlands
Spain
Sweden
United
Kingdom
Total
10% above or below
11,061
5,847
4,667
6,127
235,942
48,613
11,359
98,814
49,386
93,935
19,232
86,952
671,935
4% above
2,057
1,074
872
1,177
46,119
8,861
2,185
18,618
9,189
17,654
3,738
14,522
126,066
48
Table 4: Descriptive Statistics
This table presents descriptive statistics for the entire distribution on the size variables by country for the full sample period.
Sales and total assets are presented in thousands of local currency. %available refers to the percent of observations with nonmissing values for that variable.
Austria
(n=612,124)
Total assets
Sales
Employees
Median
404
2,000
5
10%
36
300
1
25%
108
760
2
75%
1,503
7,000
15
90%
5,464
26,147
40
Mean
6,256
16,488
25
%available
99.0%
20.2%
38.0%
Belgium
(n=1,452,505)
Total assets
Sales
Employees
159
165
2
24
24
1
60
69
1
401
434
5
898
1,264
10
1,067
2,203
6
100.0%
22.6%
35.5%
Denmark
(n=581,438)
Total assets
Sales
Employees
1,456
409
1
134
0
0
414
49
0
4,503
1,620
3
12,353
4,885
7
10,271
6,376
3
100.0%
14.8%
30.2%
Finland
(n=900,147)
Total assets
Sales
Employees
122
162
3
12
7
1
37
43
1
390
540
8
1,228
1,677
20
1,538
1,751
13
99.9%
95.1%
45.4%
France
(n=4,325,366)
Total assets
Sales
Employees
188
255
3
35
29
1
80
100
2
435
613
6
942
1,365
11
490
636
6
100.0%
99.8%
39.7%
Germany
(n=4,698,158)
Total assets
Sales
Employees
167
580
20
23
80
2
43
238
5
643
1,947
76
2,346
9,556
185
3,494
9,056
89
100.0%
20.7%
7.3%
Ireland
(n=537,657)
Total assets
Sales
Employees
185
219
6
8
10
2
42
42
2
713
1,831
26
2,296
12,962
63
1,389
8,663
27
100.0%
4.9%
4.8%
Italy
(n=4,313,562)
Total assets
Sales
Employees
500
286
5
54
0
1
165
49
2
1,417
1,011
12
3,449
2,759
23
1,575
1,239
12
100.0%
99.7%
34.0%
Netherlands
(n=3,626,963)
Total assets
Sales
Employees
373
528
1
31
14
1
118
78
1
1,049
9,340
4
2,753
44,759
14
6,183
37,765
7
99.9%
2.0%
61.0%
Spain
(n=4,676,679)
Total assets
Sales
Employees
318
275
4
42
28
1
112
96
2
919
761
8
2,580
1,982
17
1,981
1,172
9
100.0%
90.8%
75.3%
Sweden
(n=2,014,529)
Total assets
Sales
Employees
1,637
1,683
2
233
3
0
581
406
1
5,036
5,752
4
15,873
18,518
11
29,526
19,792
8
99.6%
98.3%
96.3%
United
Kingdom
(n=9,498,711)
Total assets
Sales
Employees
64
115
24
2
6
2
13
30
4
333
806
83
1,411
7,203
215
6,285
8,712
152
100.0%
17.9%
4.9%
49
Table 5: Estimates of Frequency of Size Management
This table presents estimates of the frequency of size management in Germany, Italy, Spain, and the United Kingdom in time
periods when the disclosure and audit thresholds coincide. Estimates of firm-years managed are presented only for thresholds
where the left standardized difference is significant at the .01 level (see Figure 1 or Table 6); entries where the left standardized
difference is not significant at the .01 level are noted with a -.
Bin size is 2% of the threshold value. The estimates of firm-years managed (range and percentage) assume that size management
results in observations moving from only the two intervals above the threshold to only the two intervals below the threshold.
Expected frequencies for the two bins above and two bins below the threshold are calculated assuming a linear relationship
between the third bin below and third bin above the threshold. For the range estimate, one side of the range is calculated by
summing the deviations from this expected linear relationship in the two bins immediately below the threshold. The other side of
the range is calculated by summing the deviations from the expected linear relationship in the two bins immediately above the
threshold. The percentage estimate of firm-years managed is equal to the difference between the actual number of observations in
the bin immediately below the threshold and the expected number based on the expected linear relationship between the third bin
below and third bin above the threshold, expressed as a percentage of the actual number of observations in the bin immediately
below the threshold.
Panel A: Germany
Range estimate of firm-years managed at threshold
Percentage estimate of firm-years managed at threshold
Total assets
199 - 814
12.0%
Sales
-
Employees
178 - 975
42.6%
Panel B: Italy
Range estimate of firm-years managed at threshold
Percentage estimate of firm-years managed at threshold
Total assets
-
Sales
-
Employees
-
Panel C: Spain
Range estimate of firm-years managed at threshold
Percentage estimate of firm-years managed at threshold
Total assets
120 - 250
2.6%
Sales
476 - 642
12.4%
Employees
388 - 567
5.7%
Panel D: United Kingdom
Range estimate of firm-years managed at threshold
Percentage estimate of firm-years managed at threshold
Total assets
1330 - 2811
20.8%
Sales
-
Employees
-
50
Table 6: Summary of Standardized Differences by Threshold
This table presents standardized difference statistics for each size variable for the sample countries. Panel A presents statistics for countries where the disclosure and audit thresholds
coincide. Panels B and C present statistics at disclosure (Panel B) or audit (Panel C) thresholds for countries where the thresholds do not coincide. For Ireland and the United
Kingdom (highlighted in gray) there are some time periods where the thresholds coincide and some periods where they do not (see also Table 2), so these countries have statistics
both in Panel A and in Panels B and C. The blank entries for Ireland reflect the fact that the disclosure and audit thresholds were separate for the entire sample period for sales,
whereas the disclosure and audit thresholds were coinciding for the entire sample period for employees. The blank entries for the United Kingdom reflect the fact that the disclosure
and audit thresholds were coinciding for the entire sample period for employees.
The statistics are left standardized difference test statistics as defined in Burgstahler and Chuk [2014]. Bin width is 2% of the total assets and sales threshold values and 1 employee
for employee thresholds. Standardized difference statistics significant at the 1% level (one-tailed) are noted with a † superscript. Entries are noted with a - where standardized
differences are not meaningful due to either (1) low power, operationalized as an average number of observations in the bins used for the standardized difference statistic less than
100, or (2) evidence that the Amadeus data relies on estimates from national credit bureaus that invalidate the assumption of a smooth distribution even in the absence of size
management. For France, tests of size management at the employees disclosure and audit thresholds at 20 and 50 employees are strongly biased by employment law thresholds
imposed at adjacent levels of employee count, so the employees thresholds for France are also noted with a -.
Total assets
Austria
Belgium
2.56†
Denmark
Finland
France
Sweden
United
Kingdom
Germany
Ireland
Italy
Netherlands
Spain
0.97
8.16†
0.28
0.29
1.42
3.29†
21.93†
2.27
-
8.69†
1.69
-0.85
-
3.76†
1.35
Panel A:
Coinciding
Thresholds
Sales
-
-0.73
1.49
Employees
-
-0.24
25.48†
Panel B:
Separate
Disclosure
Thresholds
0.50
0.35
-0.24
2.02
0.43
-
Sales
-
-1.27
1.78
-
-0.03
1.05
Employees
-
-
-
Panel C:
Separate
Audit
Thresholds
Total assets
-
0.88
Total assets
5.75†
2.58†
-
Sales
3.34†
-
10.37†
Employees
-
51