Non-Audit Services and Earnings Management: U.K. Evidence

Abstract

Using a sample of U.K. firms for the period 1996 to 1998, we provide empirical evidence on the relation between NAS purchase and three proxies for earnings management: 1) the likelihood that client firm accounting practices during the sample period were publicly criticized or subject to regulatory investigation; 2) the likelihood that client firms were required to restate prior financial statements or adjust current year results upon adoption of FRS 12, which was intended to curb opportunistic use of provisions; and 3) the mean absolute value of client discretionary working capital accruals over the sample period. The level of NAS purchase is measured, alternately, as 1) the ratio of non-audit to total auditor fees, 2) the natural log of NAS fees, and 3) the decile rank of a particular client's NAS fees given all NAS fees received by the audit firm practice office. With one exception, we find that all three measures of earnings management are positively and significantly associated with the three measures of NAS purchase.

Keywords: Non-audit services, public criticism and regulatory investigation, financial restatements, discretionary working capital accruals

JEL Classification: M41, M43, M49