Non-audit services provided to audit clients,independence of mind and independence in appearance: latest evidence from large UK listed companies

This paper investigates whether the provision of non-audit services (NAS) to audit clients impairs auditor independence of mind and independence in appearance. The main contributions of this paper are in terms of its timeliness with respect to regulatory changes, the simultaneous examination of both forms of auditor independence and the methodological innovation whereby it uses a variable derived from the level of abnormal audit fees as a moderating variable in order to capture the direct impact of the NAS fee level on auditor independence as well as how its influence is moderated by the level of unexpected audit fees. Our results indicate that auditor independence of mind is compromised by the size of NAS fees, particularly for clients who pay below the level of expected audit fee. The stock market perceives that auditor independence is compromised by NAS fees but, at the same time, additional tests indicate that there are benefits that accrue from NAS and, in particular, the relation between return and non-discretionary net income is increasing in NAS fees. The balance of evidence suggests that the European Union is correct in undertaking some reform of the auditing market.     

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.     

The pricing of audit and non-audit services in a regulated environment: a longitudinal study of the UK life insurance industry

This paper studies the relationship between audit and non-audit service fees paid to the statutory auditor by UK life insurance firms, utilising an extensive panel-data sample set for the period 1999–2009. Consistent with a knowledge spillover (impairment of independence) hypothesis, we predict and find that audit fees are positively (negatively) associated with actuarial (tax service) fees. Additionally, our results indicate that regulatory changes enforced after 2004 deterred UK life insurance firms from purchasing non-audit services that are perceived to impair auditor independence. Finally, we find evidence concerning the inter-temporal determination of audit fees.     

企业集团统一审计与审计质量

企业集团是新兴市场国家非常普遍的企业组织方式。审计质量问题研究的已有文献通常关注的是单个公司,本文则关注在同一实际控制人控制下的企业集团中,多家上市公司选择同一家会计师事务所审计,即集团统一审计是否会影响审计质量。研究发现,较小规模事务所进行的集团统一审计,其审计质量更差;而较大规模事务所进行的集团统一审计,则未发现其对审计质量产生显著影响。     

Non‐audit Services and Auditor Independence Depending on Client Performance

We posit that the effect of non‐audit fees on auditor independence in Korea is based on audit client performance. Further, we suggest that an audit client with low performance has an incentive to purchase non‐audit services (NAS) from an incumbent auditor to facilitate earnings management and steer accounting practices in a preferred direction. We find evidence that as non‐audit fees in Korea increase, auditor independence is reduced only for low‐performing audit clients. Thus, unconditional prohibition of NAS seems unnecessary. Regulators and policymakers should examine the motivation for purchasing NAS, particularly among audit clients with poor performance.     

Public Disclosure of Audit Fees and Bargaining Power between the Client and Auditor: Evidence from China

Before the public disclosure of audit fees was mandated, it was unlikely for an audit client to have accurate information about how much other companies were charged by their auditors. Public fee disclosure decreases the cost of auditees' access to audit fee information for the auditor's portfolio of clients and is thus likely to increase the relative bargaining power of auditees over auditors when they negotiate audit fees. Using both proprietary and public audit fee data before and after public fee disclosure was mandated in China, we provide evidence consistent with the preceding conjecture. We find that public fee disclosure reinforces the magnitude of audit fee decreases for overcharged clients and weakens auditors' ability to raise audit fees for undercharged clients. These findings suggest the existence of unintended consequences of public fee disclosure regulation, the original rationale of which was a concern about audit pricing practices that could undermine auditor independence.     

Audit market structure,fees and choice in a period of structural change: Evidence from the UK – 1998–2003

This paper presents evidence on audit market concentration and auditor fee levels in the UK market in the crucial period of structural change following the PricewaterhouseCoopers’ (PwC) merger and encompassing Andersen’s demise (1998–2003). Given the current interest in auditor choice, analysis is also undertaken at the individual audit firm level and by industry sector. There is evidence of significant upward pressure on audit fees since 2001 but only for smaller auditees. Audit fee income for top tier auditors (Big 5/4) did not change significantly while the number of auditees fell significantly, consistent with a move towards larger, less risky, clients. A decomposition analysis of the aggregate Big 5/4 concentration ratio changes over the period identifies the impact of four distinct consumer-based reasons for change: leavers; net joiners; non-par auditor switches; and (only for the audit fees measure) audit fee changes. Andersen’s demise markedly reduced the level of inequality among the top tier firms but PwC retained its position as a ‘dominant firm’. On switching to the new auditor, former Andersen clients experienced an initial audit fee rise broadly in line with inflation, with no evidence of fee premia or discounting. They also reported significantly lower NAS fees, consistent with audit firms and auditees responding to public concerns about perceptions of auditor independence. There is no general evidence of knowledge spillover effects or cross-subsidisation of the audit fee by NAS. The combined findings provide no evidence to indicate that recent structural changes have resulted in anticompetitive pricing; the key concerns remain the lack of audit firm choice and issues concerning the governance and accountability of audit firms.     

Audit and non-audit fees and capital market perceptions of auditor independence

This study provides evidence on whether auditor independence-in-appearance, proxied by earnings response coefficients, is related to the non-audit fee ratio (non-audit to total fees from a client) or client importance (total fees from a client as a percentage of the total revenues of the audit firm). The results from large samples over the period 2001–2006 show, contrary to popular belief and the findings of some prior studies, that there is no evidence of a relation between perceived auditor independence and the non-audit fee ratio. However, perceived auditor independence is negatively associated with client importance, consistent with the economic theory of auditing. Our paper adds to the literature by examining the relative importance of non-audit fee ratios and client importance as determinants of independence-in-appearance.     

Audit firm tenure and financial restatements: An analysis of industry specialization and fee effects

This study investigates the relation between audit firm tenure and clients’ financial restatements. Specifically, we extend the audit tenure literature by assessing restatement-based reporting failures using dimensions of auditor expertise and independence previously assumed to underlie short and long audit tenure problems. Short tenure expertise and independence effects are hypothesized using audit firm industry specialization and audit fees as proxies. Long tenure independence effects are hypothesized using nonaudit fees as a proxy. Using matched-sample logistic regression and 382 companies with and without financial restatements during 2000–2004, the results support prior findings by indicating a negative relation between the length of the auditor–client relationship and the likelihood of restatement. For short tenure engagements, we find that auditor industry specialization and audit fees are negatively related to the likelihood of restatement. This result is consistent with concerns about reduced audit quality due to a lack of client-specific knowledge and low audit fees on new audit engagements. Alternatively, the long tenure results indicate an insignificant relation between nonaudit fees and the likelihood of restatement. This finding contradicts independence concerns about nonaudit fees paid to entrenched auditors.     

Disclosure Of Audit Committees by Public Companies in Australia 1988–1990

The existence of audit committees in public companies can improve the quality of the financial reporting process, aid the actual and perceived independence of both the internal and external auditors, and improve financial statement users' confidence in the quality of the information. These benefits will be enhanced by disclosure of audit committees in the financial statements. This study examined the incidence and form of the disclosure of audit committees in annual reports by major Australian public companies over the period 1988–1990. The results showed that disclosures by larger companies increased during this time. Rates of disclosure varied considerably depending on the auditor and was positively associated with the size of the organisation. Companies with audit committees are encouraged to consider enhanced methods of disclosure such as those outlined in AUP 31 Communication with an Audit Committee.     

Audit Committee Financial Expertise,Litigation Risk,and Auditor‐Provided Tax Services*

The Sarbanes‐Oxley Act (SOX) greatly expanded audit committees' oversight responsibilities by requiring that they preapprove all non‐prohibited non‐audit services (NAS). Using data from 2003 to 2011, we find that tax NAS are significantly lower when accounting financial experts (ACT‐FEs) serve on the audit committee, suggesting that ACT‐FEs consider auditor independence risk, perceived and/or real, more than other members, including supervisory experts, to the point of not accepting any tax NAS, not even compliance. However, in firms with higher ex ante litigation risk, ACT‐FEs approve relatively more tax NAS than other members, suggesting that they accept the costs of a perceived lack of auditor independence from tax NAS in return for the potential benefits of increased financial reporting quality arising from tax NAS. Our analysis by subperiod (2003–2006 vs. 2007–2011) shows that this result is significant only in the second period. ACT‐FEs' differential evaluation of the trade‐off between the benefits and costs of joint audit and tax NAS provision between the two periods suggests the need for additional research in later post‐SOX years.     

AUDITOR INDEPENDENCE,AUDIT QUALIFICATIONS AND THE PROVISION OF NON-AUDIT SERVICES: A NOTE

This paper presents the results of a study designed to investigate the question of whether there is the potential for an appearance of auditor independence impairment when higher levels of non-audit services are provided to audit clients. This question was investigated by analysing the audit reports for a sample of publicly listed companies over the period 1980 to 1989. The results of the analysis indicate that the auditors of companies not receiving an audit qualification of any type over the period derived a significantly higher proportion of their remuneration from non-audit services fees than the auditors of companies receiving at least one audit qualification. This result is driven by the non-Top 100 companies in the research sample. These findings could suggest that auditors are less likely to qualify a given company's financial statements when higher levels of non-audit services fees are derived. This could convey the view that the independence of the auditors of these companies may have been compromised.     

Audit Firm Tenure,Non‐Audit Services,and Internal Assessments of Audit Quality

We use data from internal assessments of audit quality in a Big 4 firm to investigate the impact of audit firm tenure and auditor‐provided non‐audit services (NAS) on audit quality. We find that first‐year audits receive lower assessments of audit quality and that quality improves shortly thereafter and then declines as tenure becomes very long. Partitioning our sample between SEC registrants and private clients, we find that the decline in audit quality in the long tenure range is attributable to audits of private clients. For audits of SEC registrants, the probability of a high quality audit reaches its maximum with very long tenure. We also find that audit fees are discounted for first‐year audits but auditor effort is higher than in subsequent years. We find no association, on average, between total NAS fees and audit quality in the full sample but observe that total NAS fees are positively associated with quality for SEC registrants and negatively associated with quality for privately held clients. Our findings are important for regulatory policies related to audit firm tenure and auditor‐provided NAS.     

The impact of directors’ and officers’ insurance on audit pricing: Evidence from UK companies

This paper examines the impact of directors’ and officers’ (D&O) insurance on audit pricing in a large sample of UK companies. The existence of D&O insurance is expected to exert a dual impact on auditors’ pricing decisions. The presence of an additional source of funds to satisfy stakeholder claims in the event of audit client failure suggests that audit fees in insured companies should be lower. Alternatively, recent research has identified a positive link between the presence of D&O insurance and a number of characteristics traditionally associated with more expensive audits. The main objective of this study is to ascertain which of these influences pre-dominates. Analysing a sample of 753 UK listed companies in the early 1990s, when companies were obliged to disclose the presence of D&O insurance, this study shows that D&O insurance is associated with higher audit fees. It also confirms that insured companies are larger, more complex and present a greater audit risk (using a range of measures) than uninsured companies. Further analysis suggests that the impact of D&O insurance on audit fees may be influenced by company size, auditor size, and the extent of non-executive presence on the company's board.     

Audit Fees, Non-Audit Fees and Auditor Going-Concern Reporting Decisions in the United Kingdom

The accounting profession has come under increased scrutiny over recent years about the growing number of non-audit fees received from audit clients and the possible negative impact of such fees on auditor independence. The argument advanced is that providing substantial amounts of non-audit services to clients may make it more likely that auditors concede to the wishes of the client management when difficult judgments are made. Such concerns are particularly salient in the case of reporting decisions related to going-concern uncertainties for financially stressed clients.
 This study empirically examines audit reports provided to financially stressed companies in the United Kingdom and the magnitude of audit and non-audit service fees paid to the company's auditors. We find that the magnitude of both audit fees and non-audit fees are significantly associated with the issuance of a going-concern modified audit opinion. In particular, financially stressed companies with high audit fees are more likely to receive a going-concern modified audit opinion, whereas companies with high non-audit fees are less likely to receive a going-concern modified audit opinion. Additional analyses indicate that the results are generally robust across alternative model and variable specifications. Overall, evidence supports the contention that high non-audit fees have a detrimental effect on going-concern reporting judgments for financially stressed U.K. companies.     

Do Non–Audit Service Fees Impair Auditor Independence? Evidence from Going Concern Audit Opinions

We find no significant association between non–audit service fees and impaired auditor independence, where auditor independence is surrogated by auditors' propensity to issue going concern audit opinions. We also find no association between going concern opinions and either total fees or audit fees. In addition, our findings are robust to controlling for unexpected fees, to controlling for endogeneity among our variables, and to several alternative research design specifications. Our results are consistent with market–based incentives, such as loss of reputation and litigation costs, dominating the expected benefits from compromising auditor independence.     

The Impact of Managing Director Changes and Financial Distress on Audit Qualification and Auditor Switching

Abstract:   This study examines the interactive effects of change in managing director/chief executive officer (MD) and financial distress together with five control variables (type of audit firm; audit fees; gearing; time; and company size) on first, audit opinion and secondly on auditor switching. Based on a sample of 297 UK listed companies between 1987 and 2001, we find that companies that are financially distressed and change their MD are most likely to receive a qualified audit report, ceteris paribus . In addition, we find evidence of both familiarity and intimidation threats and that the probability of a switch increases with the severity of qualification.     

Costs Associated With Going-Concern-Modified Audit Opinions: An Analysis of the Australian Audit Market

This article examines the potential costs to Australian auditors and their clients from the issuance of first-time going-concern-modified audit opinions. We examine the population of Australian companies receiving a first-time going-concern-modified audit opinion during the period 1994–97 and a matched sample of financially distressed firms receiving a clean audit opinion. Results indicate that auditor switching is positively associated with receipt of a going-concern-modified opinion. However, we find no empirical evidence that there is a self-fulfilling prophecy of increased probability of company failure following the issuance of a going-concern-modified opinion for the Australian companies in our study. Our analyses of lost audit fees indicate that auditors issuing first-time going-concern-modified audit opinions lost proportionately more fees by losing clients (through switching or company failure) than firms not issuing a going-concern-modified opinion to financially stressed clients.     

Auditor Concentration: A Replication and Extension for the UK Audit Market 1991–1995

This paper examines the issue of auditor concentration in the UK during the period from 1991 to 1995. It shows that in 1995 the Big Six held 75% of the total number of audits and collectively earned 92% of the total audit fees. There was only a small increase in auditor concentration during the five year period, resulting from companies switching from small audit firms to Big Six and newly listed companies choosing a Big Six firm. The paper also examines auditor concentration within industries. Finally, the study assesses the measurement methods most commonly used in auditor concentration studies.     

Consequences of adopting an expanded auditor’s report in the United Kingdom

The United Kingdom has recently required an expanded auditor’s report for large public companies. We investigate whether this requirement is associated with an increase in the decision usefulness of the auditor’s report and whether it has indirect consequences on audit fees and quality. Our analyses cover four years surrounding the changes, including companies that transitioned to the new regime and companies that continued issuing the previous report’s format. We do not find evidence that the regulatory change significantly affected investors’ reaction to the release of auditors’ reports, audit fees, or audit quality. Furthermore, we do not find that variation in the expanded reports’ content has affected these outcomes. Although companies with long reports pay comparatively higher fees, the mere increase in disclosure does not affect audit fees or quality. Collectively, our evidence is consistent with the expanded auditor’s report providing little incremental information to investors.