The Effects of Joint Provision and Disclosure of Nonaudit Services on Audit Committee Members' Decisions and Investors' Preferences

Abstract

Recent corporate governance reforms that require audit committees to pre-approve audit and nonaudit services increase audit committees' accountability to third parties for actual auditor independence and audit quality. Other SEC reforms mandate the disclosure of fees for auditor-provided services and are aimed at influencing investors' perceptions of auditor independence. These fee disclosures also reveal audit committees' pre-approval decisions, enhancing public accountability. Thus, audit committees may be less willing to hire auditors for nonaudit services to avoid fee disclosures, even when joint provision improves audit quality. One hundred experienced corporate directors, responding as audit committee members or investors, participated in an experiment in which we manipulated the effect of the auditor's provision of nonaudit services on audit quality and the fee disclosure requirement. We find that audit committee members are more likely to recommend joint provision if audit quality improves, consistent with investors' preferences. However, unlike investors, committee members are more reluctant to recommend joint provision when public disclosures are required, even at the expense of audit quality. These findings offer evidence about an indirect effect of recent reforms.