Do Accounting Firm Consulting Revenues Affect Audit Quality? Evidence from the Pre- and Post-SOX Eras

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The Big 4 accounting firms have experienced a steady increase in the proportion of their revenues generated by providing consulting services post-SOX, primarily to nonaudit clients. Regulators have expressed concerns about the potential implications of this increase for audit quality. In contrast, the accounting firms assert that the expertise developed by their consulting professionals helps them to provide better quality audits. We examine the relation between the proportion of accounting firm consulting revenue to total revenue and audit quality, measured using financial statement misstatements. Our results suggest that, on average, higher consulting revenues are not associated with impaired audit quality. However, higher consulting revenues are associated with reduced audit quality among clients with lower litigation risk. These results support the argument that a cultural shift associated with the provision of more consulting services, even to nonaudit clients, can adversely affect audit quality in some circumstances (e.g., when litigation risk-related incentives for high audit quality are weaker). In addition, although the effect of higher consulting revenues only impacts audit quality among low litigation risk clients, results of earnings response coefficient tests suggest that investors perceive a deterioration in audit quality when a higher proportion of accounting firm revenue is generated from consulting services regardless of the client’s level of litigation risk. These results suggest that regulator and investor concerns about the provision of consulting services (at least at the levels we observe) may be warranted, but only among clients where opposing incentives to provide high audit quality are weaker.