Audit Fees, Non-Audit Services and Auditor-Client Economic Bonding

39 Pages Posted: 23 Feb 2007

See all articles by Jeffrey Coulton

Jeffrey Coulton

UNSW Business School

Caitlin M. S. Ruddock

UNSW Australia Business School, School of Accounting

Stephen L. Taylor

University of Technology Sydney; Financial Research Network (FIRN)

Date Written: February 2007

Abstract

We investigate whether auditor independence is compromised by either the mix of audit and non audit services (NAS), or simply unusually large NAS or audit fees. The results help reconcile apparently conflicting evidence in prior studies linking NAS and indicators of earnings management, as well as providing new insights on the relation between the incentive structures faced by auditors and variation in audit quality. Using the unexpected accrual component of earnings as a proxy for the effect of impaired auditor independence, we initially find that client firms purchasing an unexpectedly large NAS fee mix (i.e., relative to audit fees) display some evidence of aggressive accounting. However, when we explicitly allow for the possibly endogenous nature of unexpected accruals and unexpected NAS, this result no longer holds. In contrast, similar evidence of a positive relation between the magnitude of unexpectedly large audit fees and positive unexpected accruals still occurs (albeit more weakly) after explicitly allowing for possible endogeneity. A significant positive association between unexpected total fees (audit plus NAS) and the magnitude of positive unexpected accruals is even more robust. However, further tests shows that these "result" are confined to clients of Non-Big 6 auditors. We therefore conclude that for large audit firms, the incentive to protect larger than expected fees is outweighed by the importance of their reputation for providing high quality audits relative to smaller audit firms. The results also highlight how sensitive conclusions about possible "NAS effects" are to the choice of proxy for economic bond as well as the precise experimental design.

Keywords: Non-audit services, auditor independence, economic bond, earnings management, audit quality

JEL Classification: M49, M41, M43

Suggested Citation

Coulton, Jeffrey J. and Ruddock, Caitlin M. S. and Taylor, Stephen L., Audit Fees, Non-Audit Services and Auditor-Client Economic Bonding (February 2007). Available at SSRN: https://ssrn.com/abstract=964792 or http://dx.doi.org/10.2139/ssrn.964792

Jeffrey J. Coulton

UNSW Business School ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia
+61293855811 (Phone)
+93855925 (Fax)

Caitlin M. S. Ruddock

UNSW Australia Business School, School of Accounting ( email )

Sydney, NSW 2052
Australia
+612 9385 5806 (Phone)
+612 9385 5925 (Fax)

Stephen L. Taylor (Contact Author)

University of Technology Sydney ( email )

UTS Business School
PO Box 123 Broadway
Sydney, NSW 2007
Australia
61295143437 (Phone)
61295143513 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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