Investors' perceptions of nonaudit services and their type in Germany: The financial crisis as a turning point

Abstract

As a result of mistrust in the auditing profession, legislators and regulators continue to impose restrictions to the joint provision of audit and nonaudit services (NAS) to protect investors' interests. However, investors may perceive NAS differently than legislators, and it is an open question whether a ban on NAS always aligns with investors' interests. Little evidence exists on investors' perceptions of auditor‐provided NAS in the continental European regulatory environment, including Germany. The unique features of the German legal and regulatory environment raise questions of its ability to comfort investors that auditors resist client‐induced biases in financial reporting. To empirically investigate and test this, we use earnings response coefficients (ERC) to measure investors' perceptions of earnings quality and examine the associations between ERC and NAS fees. Surprisingly, we do not find significant associations between ERC and NAS fees for our entire sample period 2005–2015. For further examination, we split the sample before and after the financial crisis in 2008–2009. The findings indicate that, in the pre‐financial crisis period 2005–2007, investors perceive large NAS fees negatively, and this concern also extends to the components of the NAS fees. In contrast, in the post‐financial crisis period 2010–2015, investors perceive large NAS fees positively and favorable perceptions of tax services are the driver of this result. We discuss the findings in light of the regulatory initiatives in the aftermath of the financial crisis, and the recent EU supranational prohibitions of NAS and the German application of these.