Perceived Auditor Independence and Audit Firm Fees

Abstract:     
Regulations requiring the disclosure of fees paid to an auditor for audit and non-audit services (NAS) responded to concerns that such payments are potentially detrimental to auditors' actual or perceived independence. Although empirical studies, which tend to focus on NAS fees alone, have failed to produce unequivocal evidence of detrimental effects on auditor independence, the actions of regulators, auditor firms and auditees is consistent with the belief that economic bonding can at least impair perceived levels of auditor independence.

This paper studies perceived auditor independence impairment by examining the relationship between levels of total auditor fees (audit and NAS fees combined) and auditees' market value for a sample of UK firms over a six year period. The paper's methodological innovation is its use of a valuation framework to overcome some of the difficulties associated with prior methods such as event study or assessment of audit quality. A further contribution is its examination of the possibility that any relationship between total fees and perceived auditor independence may not be linear, as assumed in prior empirical studies. In this, we build on the contribution of Francis (2006), who speculates that impairment may occur only at high levels of (NAS) fees.

Studying these relationships over a six-year period, this paper provides evidence that shareholders perceive a threat to auditor independence only at high total fee levels. At lower levels, total fees are positively related to firm value, which is consistent with observed fees paid by firms on a regular annual basis. These results imply that disclosure of NAS and audit fees are of relevance to investors and that specific prohibition of the supply of NAS by auditors to auditees is unnecessary.

Number of Pages in PDF File: 32

Keywords: auditor independence, audit fees, non-audit services, firm valuation

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