Nonaudit Service Fees and Auditor Independence: Empirical Evidence from the Oil and Gas Industry

Abstract

This study examines the empirical relationship between nonaudit service fees and auditor independence for firms operating in the oil and gas industry. Oil and gas firms are chosen because of their unique operating characteristics and complexities that distinguish them from firms in other industries. This study is undertaken based on the notion that analyzing a single industry by implicitly factoring industry-specific effects provides a better understanding of the relationship between nonaudit service fees and auditor objectivity. This study is useful because conflicting prior evidence exists as to whether auditors compromise their independence in an effort to retain clients who pay high nonaudit fees. Abnormal accrual adjustment of the sample oil and gas firms is used as a measure of clients' accounting discretion exercised to opportunistically manage reported financial numbers. The results show that the magnitude of the abnormal accrual adjustment is not related to any nonaudit fee constructs employed in the study in the presence of several other firm characteristics incorporated in the analyses. Therefore, the study does not find evidence that the relative level of nonaudit service fees in the oil and gas firms impairs auditors' objectivity in assurance functions. The results are opposed to the results in Frankel, Johnson, and Nelson (2002) but are consistent with the results in Chung and Kallapur (2003) and Reynolds, Deis, and Francis (2004).