Non-Audit Services in Audit Committee Interlocked Firms, Financial Reporting Quality, and Future Performance

Abstract

We investigate whether board-interlocked firms via an audit committee (AC) board member exhibit correlated non-audit service (NAS) purchases, and whether financial reporting quality and future firm performance vary with the amount of correlated NAS purchases from the AC interlock. We find that AC-interlocked firms have positively correlated total NAS and three NAS sub-types – Tax, Assurance, and Other – in the overall sample period from 2000-2016, and in each of the sub-periods pre- and post-SOX. Firms with a larger NAS component that is explained by the AC interlock tend to exhibit lower financial reporting quality. We also find evidence that firms with higher AC-interlocked NAS purchases are associated with lower future performance, although this association exists only in the pre-SOX period. Overall, the evidence suggests that greater NAS purchases among AC interlocked firms can have a detrimental effect on financial reporting quality and auditor independence. While these detrimental effects are concentrated in the pre-SOX period when there were less restrictions on NAS purchases, we find some evidence that the association with lower financial reporting quality persists in the post-SOX period.