Non-audit Service Fees Research Articles

Characteristics of auditors’ non-audit services and accruals quality in Malaysia

PurposeThe purchase of non-audit services from incumbent auditors has generated considerable attention. This study aims to examine the relationship between characteristics of non-audit services, namely, the recurrence and types of services, and accruals quality in Malaysia.Design/methodology/approachThis study analyzed hand-collected audit and non-audit fees of 1,117 observations from Malaysian firms from 2009 to 2011. This study used descriptive analysis, univariate tests and multivariate regression to investigate the potential effect of non-audit services on accruals quality.FindingsNon-audit services are associated with lower accruals quality. Recurring and non-recurring non-audit service fees are detrimental to the quality of accruals, as are all types of recurring non-audit services. Only non-recurring audit-related services decrease accruals quality. The results demonstrate that provisions of non-audit services create economic bonding, and thus a threat to auditor independence. Results remain robust with the inclusion of corporate governance and institutional variables.Research limitations/implicationsThe sample period might represent a limitation as it only covers three years of data. This limitation is mainly because of the nature of data collection of the non-audit services fees.Practical implicationsThe findings could suggest a refinement on the Malaysian Institute of Accountants (MIA) by-laws focusing on auditor independence, and it could assist other regulative bodies such as the Securities Commission, the stock exchange (Bursa Malaysia) in ensuring better governance on the provision of non-audit services.Originality/valueThis study is the first that provides evidence on the relationship between non-audit services, types, and recurring and non-recurring non-audit services and accruals quality in Malaysia.

On the Relationship between Audit Tenure and Fees Paid to the Audit Firm and Audit Quality

We investigate the impact of audit firm tenure, partner tenure, audit fees, fees for non-audit services and total fees on audit quality, as measured by discretionary accruals. Our sample consists of Spanish non-financial public companies for the years between 2006 and 2013. Results indicate that audit quality increases with audit firm tenure but decreases with partner tenure. Moreover, the level of fees paid to the audit firm seems to have a negative impact on audit quality, which is mainly driven by fees for audit services. In this regard, we do not observe any significant relationship between fees for non-audit services and audit quality. Our results also show that the negative relationship between either long partner tenures or high fees and audit quality does not occur when the tenure with the audit firm is long. Therefore, long audit firm tenures do not only seem to involve higher audit quality ‘per se’, but also moderate the negative effects of partner tenure and audit fees on audit quality. The results of this study, which are robust to several sensitivity checks, may be relevant for the current debate on auditor rotation and the joint provision of audit and non-audit services.

Analysis of the Sarbanes-Oxley Ban on Non-Audit Services From an Auction Model Perspective

This study analyzes the impact of the Sarbanes-Oxley Act’s (SOX) ban on providing both auditing and nonaudit services by auditors to their clients. We use a first-price private value auction to compare a setting in which auditors can compete for both audit and nonaudit services with an auction in which they can compete for only one of the two services. Consistent with empirical studies, we show that the ban on nonaudit services results in fee hikes for both audit and nonaudit services, as the number of bidders (audit firms) is smaller in the post-SOX setting relative to pre-SOX setting in both auctions. Consequently, we demonstrate that, after the ban, payoffs have increased for audit firms and decreased for their clients, due to the increase in both audit and nonaudit services fees. Finally, we show that increasing the penalty for an audit failure, contrary to common wisdom, results in improved payoffs for audit firms.

The effects of non-audit services on auditor independence: An experimental investigation of supervisory board members’ perceptions

Based on the notion that the simultaneous provision of audit and non-audit services (NAS) to clients may endanger auditor independence, current European auditing regulation prohibits the provision of most NAS to audit clients, and limits total fees for NAS (European Parliament and the Council of the European Union, 2014). There is, however, only limited evidence on whether real insiders perceive the provision of NAS as negatively affecting auditor independence. Therefore, this study experimentally investigates the perceptions of German supervisory board members on auditor independence when auditors simultaneously provide NAS and audit services. The results of the study show that the provision of NAS is perceived as having a negative effect on auditor independence. Furthermore, in distinguishing between various forms of NAS, human resource consulting is perceived as having the most negative impact. The results contribute to the debate in the European Union (EU) on whether or not to further restrict the provision of NAS, and help to evaluate the EU regulation aimed at restricting the provision on NAS.

Independent and joint effects of audit partner tenure and non-audit fees on audit quality

We examine the individual and joint effects of auditors’ non-audit services (NAS)/abnormal NAS fees and length of audit partner tenure on audit quality. Our results raise questions about the ‘one size fits all’ approach imposed by the current audit partner rotation requirement in Australia as a result of (1) a learning differentiation that we observe between Big 4 and non-Big 4 auditors and (2) higher discretionary accruals associated with non-Big 4 auditors. We find abnormal NAS fees to have a positive association with both absolute and positive (income-increasing) values of discretionary accruals for firms with short audit partner tenure. NAS/abnormal NAS fees are also negatively associated with the issuance of going concern opinions to financially distressed firms when partner tenure is short. In terms of policy implications, regulators are able to gauge the efficacy of the CLERP 9 reforms which currently impose a five year mandatory audit partner rotation requirement.

Auditor Independence, Current and Future NAS Fees and Audit Quality: Were European Regulators Right?

European Union adopted the Regulation (EU) No 537/2014, which in practice prohibits the joint provision of audit and most types of non-audit services (NAS). Regulators presume that NAS fees weaken auditor independence and, as a result, impair audit quality. As the evidence at the European level does not support this view, the question of whether the new regulation will enhance auditor independence remains open. We examine the association between future NAS fees and audit quality by distinguishing among tax, audit-related and other services. We base the analysis on a sample of Spanish listed companies for the period between 2005 and 2016, finding a consistent negative association between future other NAS fees and audit quality. This suggests that the expectation of future purchases of this type of NAS may impair auditor independence. Conversely, for tax and audit-related services results are not significant. Taken together, results suggest that European regulators should seek for further evidence before banning NAS, as some of them may in fact enhance audit quality.

Types of nonaudit service fees and earnings response coefficients in the post-sarbanes-oxley era

In this study, we partition the joint provision of nonaudit services (NAS) into audit-related, tax, and all other services, and examine whether these services have varying impacts on independence-in-appearance, as measured by earnings response coefficients, over an extended period following the enactment of SOX. Prior research examining independence-in-appearance generally focuses on the years surrounding SOX and uses an aggregate NAS measure despite anecdotal and experimental evidence that there may be heterogeneity in how investors perceive different types of NAS. We first show, consistent with prior research, that an aggregate measure of NAS does not, on average, significantly influence earnings response coefficients. We then partition NAS fees by type and provide evidence that investors have negative perceptions of audit-related NAS and positive perceptions of tax NAS, and that these two effects cancel out one another in aggregate. Further investigation reveals that our results are driven by firms with high levels of accruals and smaller firms, which further corroborates our findings. We also find that measures of financial dependence fail to fully capture the channels through which NAS influences investor perceptions. Lastly, we provide evidence that perceptions of tax NAS are, in part, driven by their effect on a firm's tax strategies.

Non-audit services and audit quality: evidence from Germany

The study examines the impact of non-audit services (NAS) on audit quality. It is motivated by the new re-strictions on the joint provision of audit and NAS for EU Member State (Federal Ministry for Economic Affairs and Energy 2016, Regulation 2014, EC 2011) which are based on concerns that auditors’ provided NAS may impair auditor independence. Empirical evidence in Germany as well as in other Continental European countries is limited. We use a sample of 2567 firm-year observations from German listed firms between 2006 and 2013 and test the association between the level and type of non-audit service fees (NAS fees) paid to the auditor and audit quality. Earnings management is used as a proxy for audit quality. The findings indicate that the higher levels of NAS fees negatively affect audit quality. Separating different types of NAS shows that especially other assurance and other consultancy services have a negative impact on audit quality, whereas the level of tax services has no impact on audit quality. In further tests we show that cap on NAS fees at 70% of averaged three prior years audit fees imposed by the EU fails to prevent an impairment of audit quality, but that a moderate level of NAS does not result in lower audit quality compared to audit quality of auditors providing no NAS.

Auditor’s Characteristics and Earnings Management in India

This study investigates whether auditor’s characteristics such as its independence and professional quality act as a deterrent to earnings management in India. The existing evidence on the relationship of auditor’s independence and quality with earnings management is not conclusive. The said relationship has not been examined in the context of Indian companies. The study uses a panel data of 1,600 firm years. The study provides evidence on the presence of knowledge spillover hypothesis as negative relationship is found between fees for non-audit services and earnings management. The study does not find any significant relationship of EM with industry specialization of the auditor and size of the auditor. The results are consistent under various robustness checks.

The impact of audit committee effectiveness on audit fees and non-audit service fees

PurposeThe purpose of this study is to examine the impact of audit committee effectiveness on audit fees and non-audit service (NAS) fees in a less regulatory environment.Design/methodology/approachThe authors construct a composite audit committee effectiveness measure incorporating audit committee independence, diligence, size, financial expertise and the chairperson’s accounting expertise.FindingsThe authors find that audit committee effectiveness has a positive significant impact on both audit fees and NAS fees. This suggests that effective audit committees can hold auditors accountable resulting in better audit quality and consequently higher audit fees.Originality/valueThe link between more effective audit committees with higher NAS purchases can be explained in light of the difference in regulatory requirements providing audit committees with decision rights on the use of NASs, therefore approving more NAS and increasing NASF. Additional tests and robustness analyses confirm the results.

International Real Estate Review

We examine the geographic component of investment in audit services in the REIT industry. As REIT firms have strong incentive for information transparency and maintain high audit quality, we expect that geographic distance, as a proxy for information flow, among REIT firms, their auditor, and the Securities and Exchange Commission (SEC) offices have effects on the audit and non-audit fees paid by REIT firms. We find that: 1) REIT firms pay more audit and non-audit fees to their auditor when their headquarters are located closer to the SEC offices; 2) REIT firms pay higher audit and non-audit fees when the office of their auditor is closer to the SEC, 3) REIT firms pay higher audit and non-audit fees when the office of their auditor is located closer to their headquarters, and 4) REIT firms that are close to both the SEC and their auditor pay the highest fees for both audit and non-audit services. The results are consistent with our expectation that REIT firms desire high quality audit services and are willing to pay higher fees for them. Also, the REIT industry may enjoy the knowledge spillovers between the audit and non-audit sides and the industry specialization of their auditor.

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

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.

Quasi-Indexer Institutions and Auditor Independence: Evidence from Non-Audit Service Fees

We find that quasi-indexer ownership is negatively associated with the ratio of non-audit service fees to total fees paid to the audit firm and with the likelihood of paying the audit firm more non-audit service fees than audit service fees. Using the annual Russell 1000/2000 index reconstitution as exogenous variation in quasi-indexer ownership, we show that the dampening effect of quasi-indexer ownership on companies’ purchase of non-audit services from auditors is causal. We interpret our finding as evidence consistent with quasi-indexers’ predilection for high-quality accounting information and with their belief about the impairment effect of non-audit services on auditor independence.

Determinants of Audit Fees : Evidence from UK Alternative Investment Market

The main purpose of this study is to examine the determinants of audit fees in the Alternative Investment Market (AIM) using a sample of 23 machinery equipment companies covering the period from 2007 to 2011. The factors that have been hypothesised to be having a significant correlation with audit fees are auditee size, auditee complexity, audit risk, and auditor size. The results show that auditee size and auditee complexity are the main significant determinants of audit fees in the AIM. The findings also indicated a positive relationship between audit timing and audit fees. However, there was not significant evidence of a positive correlation between auditee risk and audit fees, which demonstrated that risk perceived by the auditor does not affect the value of fees. The results also indicated that there is no difference in the fees value between large or small clients. Moreover, the study demonstrated that there is no correlation between providing non-audit service and audit fees. Therefore, it is believed that the differences of these results with other studies in this field are due to the differences in the regulatory framework of the market selected as a sample for this study.

Audit quality across non-audit service fee benchmarks: Evidence from material weakness opinions

Regulators have voiced concerns regarding the impact of auditor provided non-audit services (NAS) on auditor independence, and by extension, audit quality. This study considers whether the provision of various levels of (NAS) influences the auditor's propensity to issue material weakness opinions (MWO). The results indicate that audit clients that purchase zero NAS, and clients that purchase NAS less than Sarbanes-Oxley's benchmark of NAS fees less than 5% of total fees, are more likely to receive a MWO than clients with a NAS at higher levels.

The Determinants of Firms' Characteristics on the Audit and Non-Audit Premium : An Analysis of Firms Listed in the Malaysia Stock Exchange

A number of studies have concentrated in exploring the audit service provided by audit firms, and the related fee charged. Factors such as an audit firm's brand and its reputation and the skills and experience of auditors' are some of the important variables influencing the audit service fee. There is a lack of evidence of a relationship between an audit premium and audit quality or the monopoly of an audit firm. In addition, a significant increase in the non-audit service fee has posed a dilemma to auditors' ethical principles. It appears that the auditors have compromised their independence, objectiveness, and professionalism to provide the financial statement assurance in order to maximize their revenues. This impression has triggered the focus of this research to revisit the determinants that control the audit and non-audit fee and empirically explore whether the above claim is valid in the context of Malaysia's business environment. This research is crucial due to increasing corporate scandals recently reported in Malaysia. The analysis was undertaken on the Annual Reports of 2012 using the partial least square (PLS) for a sample study of 100 firms listed in Malaysia's stock exchange. The analysis revealed that only the firm characteristics of foreign shareholding, market capitalization, and foreign operations have a significant relationship with both the audit and non-audit fee.

Do Family Firms Purchase More Nonaudit Services than Non‐Family Firms?

This study investigates the association between family ownership and the relative level of nonaudit service (NAS) fees paid to the incumbent auditors by public companies. Using data from S&P 1500 firms during the post‐SOX period 2002–2010, the study shows that the NAS fee ratio (the NAS fees relative to the total of audit and NAS fees) is higher for family firms than non‐family firms. The results suggest that family owners' close monitoring of their firms reduces the information asymmetry and agency problems between shareholders and managers, and as a result family firms tend to purchase more NAS from their auditors to appreciate the potential benefits of the auditors' knowledge spillovers. Additional analysis demonstrates that the positive association between family ownership and the NAS fee ratio is particularly pronounced for family firms without dual‐class shares and for those with non‐family‐member CEOs.

The Effect Of Auditor Change On Initial Audit Fee Discount And Non-Audit Services

The purpose of this research is to verify whether non-audit services are provided without additional fees at the initial audit as a strategy to win an external audit contract, which could give the appearance of initial audit fee discount. From the results, non-audit services are provided at the initial audit, and the initial audit fee is discounted accordingly, only when the independent auditor is changed from a Big 4 accounting firm to a non-Big 4 accounting firm. However, there is no meaningful relevance in any other types of changes. Therefore, if the auditor is changed from a Big 4 accounting firm to a non-Big 4 accounting firm, non-audit services are provided without additional fees in order to win an external audit contract, and the publication of audit fees with a division between the audit service fee and the non-audit service fee may give the appearance of a discounted audit service fee.

Audit fee premium: The potential effect of King III

In the wake of corporate scandals at world-renowned companies such as Enron (in 2001) and WorldCom (in 2002), public confidence in the role of the auditing profession was eroded. Consequently, in the United States, the Sarbanes-Oxley Act of 2002 (SOX) introduced a raft of mandatory corporate governance initiatives; in the United Kingdom measures included expanding the role of the Financial Reporting Council, the updating of the Combined Code in 2003 and the 2005 Company Law Reform Act; while in France, the Financial Security introduced provisions which were deemed to be very similar to SOX. In South Africa, corporate reforms included the introduction of the King I to III codes of corporate governance, the Companies Act No.71 of 2008 and the Auditing Profession Act No. 26 of 2005. In particular, King III introduced the concept of integrated reporting (IR) which recommends that companies report holistically on both financial and sustainability (economic, social and environmental) issues. In contrast to SOX, however, the application of King III is voluntary, operating on an ‘apply or explain’ basis. The introduction of SOX was postulated to have increased compliance costs and created fee opportunities for the audit profession, giving rise to questions as to whether or not the introduction of IR in King III had introduced similar opportunities for the auditing profession in South Africa, resulting in audit firms charging an audit fee premium1.In this study, multiple regression analysis was conducted on two sets of models to test two hypotheses: (i) that the BIG42 audit firms potentially charged an audit fee premium in response to the recommendations of King III on IR, and (ii) that audit fees are related to non-audit service fees. Results of the research do not show any evidence to suggest that the advent of King III was related to audit fee premiums, yet a strong relationship was found between audit3 and non-audit service fees4. Further, certain of the BIG4 audit firms were found to obtain an audit fee premium. The findings of this study add a South African dimension to the existing body of knowledge on the relationships between audit fees and governance initiatives in this context.

Do Office Managing Partners Influence Audit Quality?

This study investigates the association between the line of service (audit, tax, advisory) of Big Four office managing partners (OMPs) and both non-audit service fees and audit quality. Given that audit quality has been shown to vary across offices and because changes in office-level leadership can impact office culture, I examine the impact of the OMP’s line of service on non-audit service fees and multiple measures of audit quality. I find that when an accounting firm office changes leadership to an advisory OMP non-audit service fees increase, while audit quality suffers. These findings suggest that advisory OMPs encourage an office culture that emphasizes selling non-audit services (understates audit quality) relative to other OMPs. Overall, this study provides evidence consistent with regulators’ concerns that the recent trend toward greater advisory services at the largest accounting firms reduces their focus on providing high-quality audits, thereby leading to decreased audit quality. While these findings are robust to a battery of additional tests, caution should be exercised in overstating the regulatory implications of the observed association.