Audit and Non-Audit Fees and Capital Market Perceptions of Auditor Independence

Abstract

This study investigates investor perceptions, proxied by earnings response coefficients (ERCs), of auditor independence-in-appearance as a function of audit and non-audit fees. For a sample of 8,940 firm-years over the 2000-2002 period, we find in separate regressions that ERCs are negatively associated with the ratio of non-audit to total fees (non-audit fee ratio) and with client importance (auditors' fees from a given client divided by auditor's total revenues). When we include both in the same regression, however, only client importance remains significantly associated with ERCs. Thus our results contradict the commonly-held belief (SEC 1978, 1979, Earnscliffe Research and Communications, 1999) that perceived auditor independence is a function of the non-audit fee ratio. We also fail to find a statistically significant change in ERCs when non-audit fees increase or decrease by at least 30 percent between successive years; this result fails to support the conjecture (Coffee 2004) that investors interpret non-audit fee changes as "bribes or punishments" by clients.

Keywords: Auditor independence-in-appearance, client importance, non-audit services

JEL Classification: M41, M49, G12, G29