Shareholder Proposals on the Auditor–Client Relationship: The Case of Nonaudit Service Purchases

Abstract

This article provides empirical evidence on shareholder proposals seeking to restrict nonaudit service (NAS) purchases by public companies from their independent auditors. Our analysis is based on 104 instances of shareholder proposals seeking to restrict NAS provided by independent auditors, received by 94 firms during a unique period from 2001 to 2004 (when the Securities and Exchange Commission [SEC] allowed such proposals to proceed to shareholder votes), and a control sample that did not receive such proposals. We find that firms targeted by shareholders had higher nonaudit fee ratios. We also find that firms receiving such shareholder proposals are likely to have steeper subsequent declines in the nonaudit fee ratio than firms not receiving such proposals. Finally, considering only the subset of firms that have a shareholder vote on proposals seeking to restrict NAS purchases, the subsequent reduction in the nonaudit fee ratio is positively related to the magnitude of the proportion of votes in favor of the shareholder proposal. Our findings suggest that permitting shareholder participation in issues related to the auditor–client relationship can lead to significant changes in the nature of the auditor’s relationship with the client, and they call into question recent SEC actions permitting companies to restrict shareholder participation in issues related to auditor selection.