The Relation between Auditors' Fees for Non-Audit Services and Earnings Management

Posted: 4 May 2003

See all articles by Richard M. Frankel

Richard M. Frankel

Washington University in Saint Louis - Olin Business School

Marilyn F. Johnson

Michigan State University - Department of Accounting & Information Systems

Karen K. Nelson

Texas Christian University - Department of Accounting

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Abstract

This paper examines whether auditor fees are associated with earnings management and the market reaction to the disclosure of auditor fees. Using data collected from proxy statements, we present evidence that non-audit fees are positively associated with small positive earnings surprises, the magnitude of absolute discretionary accruals, and the magnitude of income-increasing and income-decreasing discretionary accruals. In contrast, audit fees are negatively associated with these earnings management indicators. These results are robust to a variety of alternative variable definitions and model specifications. Specifically, contrary to the claims of Ashbaugh et al. (2002), the results are robust to the use of performance-matched discretionary accruals. Moreover, contrary to the claims of Francis and Ke (2002), the results for small positive earnings surprises are robust regardless of whether the comparison group is all other earnings surprises or small negative earnings surprises. Our final set of results provide evidence of a significant negative association between non-audit fees and share values on the date the fees were disclosed, although the effect is small in economic terms.

Keywords: auditor independence, auditor fees, earnings management, discretionary accruals

JEL Classification: G12, M41, M43, M49, L84

Suggested Citation

Frankel, Richard M. and Johnson, Marilyn F. and Nelson, Karen K., The Relation between Auditors' Fees for Non-Audit Services and Earnings Management. The Accounting Review, Special Issue on Quality of Earnings, pp. 71-105, Supplement, 2002. Available at SSRN: https://ssrn.com/abstract=403160

Richard M. Frankel

Washington University in Saint Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Marilyn F. Johnson

Michigan State University - Department of Accounting & Information Systems ( email )

270 North Business Complex
East Lansing, MI 48824-1034
United States
517-432-0152 (Phone)
517-432-1101 (Fax)

Karen K. Nelson (Contact Author)

Texas Christian University - Department of Accounting ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States
817-257-7567 (Phone)

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