Non-Audit Services in Audit Committee Interlocked Firms, Financial Reporting Quality, and Future Performance
58 Pages Posted: 8 Jun 2020
Date Written: May 11, 2020
We investigate whether non-audit service (NAS) purchases are correlated among audit committee (AC) interlocked firms. We then examine whether financial reporting quality and future firm performance vary with the amount of correlated NAS purchases from the AC interlock. We find that firms in the AC interlock have positively correlated NAS for total NAS and three NAS sub-types – Tax, Assurance, and Other – in the overall sample period from 2000-2016, and in the pre-SOX and post-SOX sub-periods. Firms with a larger AC interlocked-NAS component have higher non-reliance restatements, fraud F-score, likelihood of meeting or beating analyst forecasts, and absolute discretionary accruals, lower incidence of internal control material weakness reporting by the auditor, consistent with lower financial reporting quality for such firm. Higher AC-interlocked NAS firms also have lower cumulative ROA in the future three years. Overall, the evidence suggests that AC interlocks encourage NAS contagion, and are associated with poorer financial reporting and poorer future performance. Thus, on net, the evidence is inconsistent with NAS in AC networks providing positive knowledge spillovers to benefit audit quality or firm performance, and instead, is consistent with interlocked-NAS impairing auditor independence.
Keywords: Non-audit service, audit committee interlock, financial reporting quality, performance, auditor independence
JEL Classification: M41
Suggested Citation: Suggested Citation