Contingent rents and auditors' independence: Appearance vs fact

Abstract

A common theme in discussions of auditors' independence is the concern that provision of nonaudit services may compromise auditors' independence. We use a simple model to show that although the latter argument applies in some cases, it is false in others. Specifically, we show that the presence of contingent economic rents is not sufficient for auditors to compromise their independence, nor is the lack of contingent rents sufficient to imply auditors' independence. We also show that contingent rents could increase audit quality and strengthen independence when the risk of misstatements is less than 50 per cent. Our paper provides definitions of independence in appearance and independence in fact. Although the issue of independence relates to the dual notion of appearance and fact, regulations generally focus on appearance. In contrast, the literature on auditors' independence has focused on independence in fact. We bridge the gap by formalising a definition of independence in fact, and a definition of independence in appearance.