Non-audit Service Fees Research Articles

Perceived auditor independence and audit firm fees

Regulations requiring the disclosure of fees paid to an auditor for audit and non-audit services (NAS) respond to concerns that such payments are potentially detrimental to auditors' actual or perceived independence. Although empirical studies have failed to produce unequivocal evidence of detrimental effects on auditor independence, the actions of regulators, audit firms and companies are consistent with the belief that economic bonding generated by fees can impair perceived levels of auditor independence. Using a sample of UK companies over a six year period to March 2006, we study perceived impairment of auditor independence by examining the relationship between levels of total relative fees (combined audit and NAS fees payable by a company to its auditor as a proportion of the audit firm's UK income) and market value. This paper's methodological innovation is its use of a valuation framework in this setting. A further contribution lies in dropping the assumption of linearity found in most prior empirical studies. We provide evidence that shareholders perceive a threat to auditor independence only at high total relative fee levels. At lower levels, total relative fees are positively related to company value. These results suggest that disclosure of NAS and audit fees are of relevance to investors, as is information about auditor income. Our results support the view that regulation by reference to the threshold at which total relative fees are perceived negatively is more consistent with investor preferences than prohibition of the supply of NAS by auditors to their audit clients.

Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees

ABSTRACTThis study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001–2007 as an indicator for audit failure, I find that the amount of NAS fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.Data Availability: All data are publicly available from sources identified in the study.

The Effect of Potential Lawsuit Risk on Non-Audit Service Fees and Total Fees

The Effect of Potential Lawsuit Risk on Non-Audit Service Fees and Total Fees

Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions

In this study we examine the association between audit service fees and non-audit service (NAS) fees and the auditor’s final decision regarding the type of opinion to render to a financially distressed client. Along with examining current fee levels and reporting decisions we also test the DeAngelo (1981) auditor independence model by examining the association between future fee receipts and current reporting decisions. Using data from the post-SOX reporting period of 2004-2006 and a stringent control sample, we find that the magnitude of NAS fees received in the current year is negatively related to the likelihood of the auditor modifying the audit opinion for going-concern uncertainty. We also find that current going-concern modification decisions are negatively related to total fees received by auditors in subsequent years. Our findings suggest that concerns over the relation between auditor fees and the possible impairment of auditor independence, as reflected in going-concern modification decisions, are supported in the more recent years for highly distressed clients.

Takeover premiums and the perception of auditor independence and reputation

This study investigates if there is a positive association between takeover premiums and the bidder’s perception of target firm auditor reputation and independence. Using auditor size as a proxy for auditor reputation, the results indicate that in hostile takeovers target shareholders receive a higher takeover premium when a Big 4 auditor audits the target firm prior to the takeover. This result is only significant, however, in the period prior to the highly publicised audit failures. The impact of perceived auditor independence on takeover premiums is studied using the levels and size of non-audit service (NAS) fees provided by the target firm auditor. Using three proxies for auditor independence, the results show no association between perceived auditor independence and takeover premiums. This finding is robust to partitioning the sample by auditor size, takeover hostility and splitting the sample into takeovers pre- and post- the corporate scandals that occurred in 2002.

Investors’ Perceptions of Auditors’ Economic Dependence on the Client

The authors revisit the client importance and auditor independence debate, and investigate whether investors’ perceptions of the auditor’s economic dependence has changed since the passage of the Sarbanes–Oxley Act of 2002 (SOX). Client importance is measured as the proportion of client nonaudit service fees, audit fees, or total fees to the total audit office revenue. Consistent with their hypothesis, they find a significant decrease in the association between both nonaudit services (NAS) and total fees, and the cost of equity from the pre- to the post-SOX period, indicating that investors’ concerns over auditor independence have changed in the post-SOX period. In addition, the authors find some evidence of a positive and significant association between both audit fees (2003) and total fees (2004), and cost of equity in the post-SOX period. Overall, these results indicate that the independence requirements in SOX and/or the heightened litigation environment post-SOX have, to some extent, mitigated but not completely eliminated investors’ concerns over the threat of economic fee dependence.

Nonaudit Services and Earnings Management in the Pre-SOX and Post-SOX Eras

SUMMARY Concerns about the impact of auditor-provided nonaudit services (NAS) on auditor independence arise because of (1) auditors' economic dependence on their clients, and (2) some specific types of NAS which the Securities and Exchange Commission (SEC) argues can harm auditor objectivity. The SEC's prohibition in 2003 of specific kinds of NAS led to a significant decline in NAS between 2000–2001 and 2004–2005. We argue that this decline in observed NAS fees can be used to identify firms that had a greater likelihood of impaired auditor independence in the pre-SOX period. Using discretionary accruals to proxy for earnings management, we find a positive association between discretionary accruals in the pre-SOX era and the subsequent reduction in NAS, but this was confined to income-decreasing accruals. Further, the association between downward earnings management and the decline in NAS was reduced in the post-SOX era.

Disclosure Of Nonaudit Services Fees: Perceptions Of Investors And Accounting Professionals

<p class="MsoBodyTextIndent" style="text-align: justify; line-height: normal; text-indent: 0in; margin: 0in 37.9pt 0pt 37.4pt;"><span style="font-size: 10pt; mso-bidi-font-style: italic;"><span style="font-family: Times New Roman;">This study examines investors’ and accounting professionals’ perceptions related to the necessity and form of disclosure of nonaudit service (NAS) fees pursuant to the Security and Exchange Commission’s Final Rule on auditor independence. A between-subjects design was used to examine participants’ opinions as to the need for disclosure of the performance of NAS and the particular form of disclosure that was preferred. The design incorporated four types of NAS (actuarial services, internal audit outsourcing, legal services, and software training), two levels of materiality (40 percent and 3 percent), and three categories of participants (non-Big 5 CPA firm professionals, Big 5 CPA firm professionals, and investors). A larger percentage of investors favored disclosure of NAS fees than either non-Big 5 CPA firm professionals or Big 5 CPA firm professionals. In addition, of those who favored disclosure, investors favored disclosure of the amount of NAS along with the total audit fees, regardless of the amount, while non-Big 5 CPA firm professionals and Big 5 CPA firm professionals both favored disclosure of the amount of NAS alone and only if those services exceeded a specified threshold. The investor results lend support to the SEC’s revised auditor independence rules.</span></span></p>

Auditor Compensation Pattern Of S&P 500 Corporations Before And After The Passage Of Sarbanes-Oxley Act

<p class="MsoBodyTextIndent" style="text-align: justify; text-indent: 0in; margin: 0in 34.2pt 0pt 0.5in;"><span style="font-family: Times New Roman; font-size: x-small;">The years 2001-02 were marked with an outburst of huge corporate financial failures that eroded billions of dollars from the stockholders’ equity and shook the confidence of the investor community. One of the issues that rose to the surface was the payment of huge nonaudit service fees by publicly traded companies to their auditors.<span style="mso-spacerun: yes;">  </span>In response to the outcry against the alleged role of the auditors in the corporate scandals, Congress passed Sarbanes-Oxley Act of 2002 (SOX), which imposed a prohibition on the supply of certain nonaudit services by a CPA firm to its audit clients in order to reduce the suspected<span style="mso-spacerun: yes;">  </span>revenue-dependence of auditors on their audit clients.<span style="mso-spacerun: yes;">  </span>The study described in this paper examines the pattern of auditor compensation in the years 2001 and 2004 (i.e., pre- and post-SOX periods), for a sample of large public companies, to determine how the auditor compensation has changed during this three-year period and whether the new regulations have decreased such revenue-dependence of the auditor. The study also examines if each of the Big 4 CPA firms that dominate the audit market for large public companies have experienced a change in the pattern of their revenues drawn from different sources of auditor compensation. The results show that not only the composition of auditor compensation has changed after the passage of SOX but also the overall compensation paid by the sampled companies to their auditors has gone up noticeably in many cases, primarily due to a phenomenal rise in audit fees, which still may continue to threaten the auditor’s independence in the audit process.<span style="mso-spacerun: yes;">  </span>Further, during this three-year period, each of the Big 4 CPA firms has shifted its emphasis on the different sources of its revenues from these large public companies.</span></p>

Has SOX Affected the Association between Fee Dependence and Auditors’ Going-Concern Opinions?

Recently, Li (2009) reports that an auditor’s going-concern decision is unaffected by pressure from her economically important clients in 2001, but is positively affected in 2003. Li attributes these findings to enhanced auditor independence under the Sarbanes-Oxley Act (SOX) of 2002. However, this interpretation seems premature, as failures to issue going-concern reservation are generally regarded as a serious violation of independence which auditors will try and avoid even before the passage of SOX. Moreover, several audit-related SOX provisions did not become effective until 2003. Our study sheds light on Li’s (2009) surprising findings by extending her post-SOX period to 2007 and conducting parallel analyses using a more comprehensive logistic regression model developed by DeFond, Raghunandan and Subramanyam (2002). Unlike Li (2009), we fail to find any association between the incidence of going-concern opinions and economic bonding using either model in 2004–2007. Her findings for 2003 are also very sensitive to model specification and sample choice. We then add to the models an interaction term between economic bonding and an indicator variable, denoting firms with high non-audit service fees in 2001 and hence most affected by SOX. This term is insignificant in 2003–2007, implying that SOX has not improved independence even for targeted firms. Expanding Li’s model to include five additional control variables in DeFond et al. (2002) yields qualitatively similar results as DeFond et al. Thus, the phenomena identified by Li (2009) appear to reflect auditors’ response to the aftermath of accounting scandals and/or the publicity surrounding SOX.

Assessing The Appearance Of Auditor Independence Using Behavioral Research Methodology

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">Recent archival studies have examined the association between auditor independence and non-audit services. The results of these studies<span style="mso-bidi-font-weight: bold;"> suggest that fees for non-audit services are not associated with indicators of auditor independence in fact whereas these fees are associated with financial statement users’ perceptions of auditor independence (i.e., independence in appearance). The present study attempts to reconcile these conflicting findings by using a behavioral research methodology that provides greater control over the independent variables and measures more directly financial statement users’ perceptions. Our results indicate that fees for financial information systems development services do not affect perceptions of auditor independence, whereas, fees for tax services adversely affect perceptions of independence. Overall, the results provide mixed support for the recent Securities and Exchange Commission policy changes on auditor independence. </span></span></span></p>

Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees

This study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001 – 2007 as an indicator for audit failure, I find that the amount of nonaudit (NAS) fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.

Auditor Fees and Fraud Firms

The issue of whether auditor fees affect auditor independence has been extensively debated by regulators, investors, investment professionals, auditors, and researchers. The revised SEC requirements that resulted from the implementation of the Sarbanes-Oxley Act (2002) limit non-audit services (NAS) and mandate NAS fee disclosure. The SEC’s requirements are based on the argument that auditor independence could be impairedand hence audit quality may be reducedwhen auditors audit their own work. Economic bonding leads to reduced independence, which may in turn lead to reduced audit quality. We study a sample of firms sanctioned by the SEC for fraudulent financial reporting in Accounting and Auditing Enforcement Releases (SEC-sanctioned fraud firms) and examine whether there is a relationship between auditor fee variables and the likelihood of being sanctioned by the SEC for fraud. We use SEC sanction as a measure of audit quality that has not previously been used in the literature and is more precise than some of the other proxies used for flawed financial/auditor reporting. We find, in univariate tests, that fraud firms paid significantly higher (total, audit, and NAS) fees. However, in multivariate tests, when controlling for other fraud determinants and endogeneity among the fraud, NAS, and audit fee variables, we find that, while NAS fees and total fees are positively and significantly related to the likelihood of being sanctioned by the SEC for fraud, audit fees are not. These findings suggest that higher NAS fees may cause economic bonding, leading to reduced audit quality, while higher audit fees do not appear to have the same effect. Our findings of significantly higher NAS fees in fraud firms hold after controlling for latent size effects and other rigorous testing. These results contribute to the literature that examines the SEC’s concerns about NAS, and can be used by policy makers for additional consideration.

Corporate Governance Quality, Audit Fees and Non‐Audit Services Fees

Abstract: This paper extends prior research on the relationship between governance quality and auditor remuneration. We examine the influence of audit committee effectiveness (ACE), a proxy for governance quality, on audit fees (AF) and non‐audit services fees (NASF) using a new composite measure comprising audit committee independence, expertise, diligence and size. We find that after controlling for board of director characteristics, there is a significant positive association between ACE and AF only for larger clients. Our results indicate that effective audit committees undertake more monitoring which results in wider audit scope and higher audit fees. Contrary to our expectations, we find the association between ACE and NASF to be positive and significant, especially for larger clients. This suggests that larger clients are more likely to purchase non‐audit services (NAS) even in the presence of effective audit committees probably due to the complexity of their activities. Overall, our findings support regulatory initiatives aimed at improving corporate governance quality.

Corporate Governance Quality, Audit Fees and Non-Audit Services Fees

Corporate Governance Quality, Audit Fees and Non-Audit Services Fees

Original and Revised Auditor Fee Data

SUMMARY: A significant number of companies report revised auditor fees (audit, nonaudit services, and total) in subsequent Securities and Exchange Commission (SEC) filings. We find that, on average, revised audit fees and total fees are significantly higher, and nonaudit services (NAS) fees are significantly lower than the originally reported fees. The occurrence of fee revisions decreases significantly after 2006 and does not appear to be concentrated in specific industries. In addition, we find that larger clients are more likely to report fee revisions, while clients of Big 4 auditors and clients that file late are less likely to report fee revisions. We also examine the magnitude of upward and downward fee revisions. The fee revisions likely result from the changes in the SEC's fee disclosure reporting requirements from 2001 to 2003, as well as ambiguity related to the new requirements. In addition, they also may stem from estimated billing by accounting firms prior to filing with the SEC, followed by more precise billing after the filing. Our objective is to alert managers and practitioners to the subtleties of the fee disclosure requirements relative to fees billed/paid, the disparity in fee reporting, and the necessity for reporting revised fees if appropriate. We advise audit committee members, analysts, researchers, and other users of audit fee data to use revised fee numbers and exercise caution when using originally reported fees, as they often are revised.

Non-Audit Services and Earnings Management in the Pre-SOX and Post-SOX Eras

Concerns about the impact of auditor-provided non-audit services (NAS) on auditor independence arise because of (1) auditors’ economic dependence on their clients and (2) some specific types of NAS which the SEC argues can harm auditor objectivity. The SEC’s prohibition in 2003 of specific kinds of NAS led to a significant decline in NAS between 2000-2001 and 2004-2005. We argue that this decline in observed NAS fees can be used to identify firms that had a greater likelihood of impaired auditor independence in the pre-SOX period. Using discretionary accruals to proxy for earnings management, we find a positive association between discretionary accruals in the pre-SOX era and the subsequent reduction in NAS, but this was confined to income-decreasing accruals. Further, the association between downwards earnings management and the decline in NAS was reduced in the post-SOX era.

The Determinants of Audit Fees. Further Evidence From the UK Charity Sector

Given the lack of literature and the ever growing relevance of charities, the present paper investigates the determinants of audit fees in the UK charity sector. It proposes a theoretical framework to determine the audit fee, which is empirically tested on a dataset of 119 “largest” charities. The paper also investigates the presence of a fee premium associated with (now) Big4 audit firms and expertise in charity auditing, and compares the results with those of a leading study in the UK context (Beattie et al., 2001). Our findings basically confirm those of Beattie et al. (2001). The evidence shows that size, risk, and fees for Non-Audit Services (NAS) are the main determinants of audit fee determination, while, contrary to research in the private sector, the organisational complexity of the charity does not seem to have significant influence on audit fees. The results also show a positive association between audit fees and NAS fees, the presence of an audit fee premium between Big4 and non-Big4 auditors, as well as significant higher remuneration for the auditors’ expertise.

Has Sarbanes-Oxley Act curtailed the growth in auditor compensation or just changed its composition? A look at more recent evidence

This study takes a look at the rise in the total auditor compensation that has taken place over the past several years after the passage of Sarbanes-Oxley Act (SOX). Prior research, with the exception of a few studies, has mostly focused on the possible harmful effects of non-audit service fees on the auditor's independence. The results of those studies have been mixed, with more studies concluding that non-audit service fees threaten auditor independence. In response to such findings, the government has passed legislation (SOX) banning companies from purchasing certain non-audit services from their audit firms with a view to reducing the economic ties between a client and its auditor. However, the published data from a sample of companies show that while the amounts of non-audit fees received by audit firms have declined over the last several years, the overall auditor compensation has increased during the same period, even significantly in several cases. In most cases, the rise in the total auditor compensation has been caused by a significant rise in the audit fees paid by a company to its audit firm. The current study examines this rise in the total compensation paid by a sample of companies that are the audit clients of the Big Four CPA firms and finds that SOX has not really succeeded in reducing the economic bonding between a company and its auditor. Moreover, as total auditor compensation indicates a flow of money from clients to auditors, regardless of the service for which the money is being paid, the authors suggest that studies involving the issue of auditor compensation and its potential impact on auditor independence should focus primarily on the total auditor compensation and not just a segment of it such as non-audit service fees.

Voluntary Disclosure of Auditor-Provided Tax Service Fees

ABSTRACT: This study examines the decisions of firms to voluntarily disclose tax fees paid to their external auditors. Although the Securities and Exchange Commission (SEC) began requiring public companies to disclose fees paid to auditors in 2000, separate disclosure of tax service fees as a component of those fees was not required until 2003. During this period, there was increased scrutiny by the SEC on many aspects of the auditor-client relationship, and by the Internal Revenue Service (IRS) on the sale of tax shelters by large public accounting firms to their clients. Hence, we predict that the decisions of firms that buy tax services from their auditors to voluntarily disclose fees for those services will be significantly influenced by political costs associated with heightened regulatory scrutiny. Results show that the likelihood of separate disclosure of tax fees in 2002 is negatively associated with the ratio of nonaudit service fees (NAS) to total fees, thus supporting the political cost hypothesis. Importantly, we find that the negative association of political cost and disclosure is exacerbated by both audit committee governance and audit firm size. We also find the disclosure decision to be positively associated with agency costs (institutional ownership and size) and negatively associated with the relative amount of deferred taxes, firm profitability, and auditor change. In summary, these results shed light on the roles played by two important players in the corporate governance structure of a firm (the audit committee and the audit firm) in determining a firm’s voluntary disclosure practices.