How Do Audit Firms Respond to Fee Pressure? Evidence of Increased Nonaudit Services and Their Impact on Audit Quality

Abstract

Recent academic research has noted a substantial decline in audit fees beginning in the mid-2000’s (Christensen et al. 2014; Ettredge et al. 2014). We investigate whether audit offices respond to audit fee pressure by increasing their focus on nonaudit services (NAS), as well as the joint effect of audit fee pressure and increasing focus on NAS on audit quality. We find a significant positive association between audit fee pressure and changes in nonaudit services at the audit office level. This relation is more evident among small and mid-sized offices, as well as non-Big 4 offices. Consistent with the prior literature, we find an association between fee pressure and lower audit quality using client misstatements. However, we also find a positive association between increased nonaudit services and client misstatements only in the presence of audit fee pressure, suggesting that audit fee pressure has a joint effect on audit quality by increasing audit offices’ focus on providing NAS, rather than audit fee pressure in isolation. Overall, our study provides evidence that audit offices’ nonaudit services are another important dimension to consider when examining the effects of declining audit fees on the audit profession.