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.     

Non-fully invested derivative-free bond index replication

The problem we address here is the replication of a bond benchmark when only a fraction of the portfolio is invested for the replication. Our methodology is based on a minimization of the tracking error subject to a set of constraints, namely (1) the fraction invested for the replication, (2) a no-short-selling constraint, and (3) a null-active-duration constraint, the last of which may be relaxed. The constraints can also be adapted to accommodate the use of interest rate and bond futures. Our main contribution, however, is our derivative-free approach to replication, which should prove very useful for managing assets when the use of derivatives is prohibited, for instance, by certain investors. We can, thus, still benefit from replicating a traditional investment in a bond index with a fraction of the portfolio according to our risk appetite. The rest of the portfolio can be invested in alpha-portable strategies. An analysis without the use of derivatives over the period from January 1, 2008 to October 3, 2011 shows that with 70–90 % invested for the replication, the annualized ex-ante tracking error can range from 0.41 to 0.07 %. We use principal component analysis to extract the main drivers of the size of the tracking error, namely, the volatility of and the differential between the yields in the objective function’s covariance matrix of spot rates. These results highlight our contribution of a generic and intuitive yet robust approach to bond index replication.     

Regulating the Market for Audit Services: A Game Theoretic Approach

We apply game theory to model how alternative mandatory audit firm rotation regimes can affect the strategic interaction between auditee and auditor firms, and analyze potential consequences on detection risk and impairment of auditor scepticism. The major results suggest that: (1) relative to an initial state with no rotation requirement but high probability for impaired auditor scepticism, imposing either short-term or long-term mandatory audit firm rotation will remove the threat to auditor scepticism and lead to higher audit fees and lower detection risk; (2) relative to long-term mandatory audit firm rotation, imposing a short-term rotation will lead to lower audit fees and higher detection risk, resulting from greater informational frictions. We further find that imposing supplementary regulatory instruments, such as increased regulatory scrutiny of the auditee and/or auditor, can be used to lower the detection risk and increase audit quality. We discuss implications of these findings for empirical research.