The Demand for Financial Statements in an Unregulated Environment: An Examination of the Production and Use of Financial Statements by Privately Held Small Businesses

ABSTRACT: We examine the financial reporting practices of small privately held businesses that are not subject to SEC regulation. Specifically, we determine the factors associated with the production and use of financial statements for firms that have discretion in the preparation of financial statements and do not face the demands of public equity markets. In addition, for firms that prepare financial statements, we determine the factors associated with the sophistication of the financial statements in terms of whether the financials are compiled, reviewed, and/or audited by a professional accountant and whether the firm produces accrual‐based financial statements. Finally, we examine the potential benefits afforded firms producing financial statements, having audited financial statements, and having accrual‐based financial statements. We find that firms with audited financial statements benefit in the form of greater access to credit and that firms with accrual‐based financial statements benefit in the form of a lower cost of credit.