Do Accounting Firm Consulting Revenues Affect Audit Quality? Evidence from the Pre‐ and Post‐SOX Eras

Abstract

In recent years, public accounting firms have experienced a steady increase in the proportion of their revenues generated from consulting services. Although growth in consulting revenue following the Sarbanes‐Oxley Act (SOX) has been generated primarily from services provided to nonaudit clients, regulators have expressed concerns about the potential implications of this increase for audit quality. In contrast, accounting firms assert that the expertise developed by their consulting professionals helps them to provide better quality audits. We examine the relation between the proportion of accounting firm consulting revenue to total revenue and audit quality and investor perceptions of audit quality. Because SOX drastically altered the source of consulting revenues for public accounting firms, we also separately examine these relations in the pre‐ and post‐SOX eras. We find evidence suggesting that before SOX, higher proportions of audit firm consulting revenues negatively impacted both audit quality and investor perceptions of audit quality. However, we do not find a statistically significant association between audit firm consulting revenues and either audit quality or investor perceptions of audit quality following SOX. Our analyses suggest that even if these relations exist following SOX, the potential economic magnitude of the effect is small.

How Do Audit Offices Respond to Audit Fee Pressure? Evidence of Increased Focus on Nonaudit Services and their Impact on Audit Quality

“…See, for example, Frankel et al (2002), Ashbaugh et al (2003), Reynolds et al (2004), Ferguson et al (2004), Kinney et al (2004), Larcker and Richardson (2004), Lisic et al (2018), and Chyz et al (2015). effort, but as owners only receiving a portion of the benefits of their individual effort (e.g., Kandel and Lazear 1992).…”

“…See, for example, Frankel et al (), Ashbaugh et al (), Reynolds et al (), Ferguson et al (), Kinney et al (), Larcker and Richardson (), Lisic et al (), and Chyz et al ().…”

“…Anecdotal evidence suggests that the SEC and PCAOB continue to scrutinize audit firms for the sale of NAS to audit clients, adding to the perceived reputational costs associated with providing NAS to audit clients (PCAOB 2012; Whitehouse 2014). Recent research also suggests investor perceptions of NAS to audit clients are negative (Lisic et al 2018). Thus, audit offices might not exert as much effort to sell NAS to audit clients as they otherwise would because of these potential reputation and litigation concerns.…”

“…However, Mowchan () examines whether office managing partners emphasize selling NAS. Lisic et al () examine the proportion of management advisory and other fees to total U.S. revenue at the accounting firm level, and Chyz et al () examine both engagement‐level and office‐level tax compliance and planning services.…”

Auditor Integration of IT Specialist Input on Internal Control Issues: How a Weaker Team Identity Can Be Beneficial

“…Audit firms typically employ IT specialists either as part of the assurance or advisory (i.e., consulting) group within the firm. Audit firms have expanded their consulting practices considerably in recent years (Rapoport 2012; The Economist 2012), with consulting related revenue exceeding audit revenue at Big 4 firms in 2013 (Lisic, Myers, Pawlewicz, and Seidel 2015). Audit specialists, including IT, serve dual roles in audit firms today: consultant on advisory engagements and auditor on integrated and financial statement audit engagements.…”