Nonaudit Services and Earnings Conservatism: Is Auditor Independence Impaired?*

Abstract

We examine whether the provision of nonaudit services (NAS) by incumbent auditors is associated with a reduction in the extent to which earnings reflect bad news on a timely basis (that is, news‐based conservatism). Reduced conservatism is expected to occur if relatively high levels of NAS result in reduced auditor independence and, ultimately, lower‐quality auditing. Because client‐specific demand for NAS is expected to vary, our proxy for the auditor‐client economic bond is the extent to which NAS purchases (relative to audit fees) are greater or less than expected. Using several different methods for identifying news‐based conservatism, we consistently find that higher than expected levels of NAS are not associated with reduced conservatism. This result is robust to allowing for endogenous NAS demand, as well as several explicit factors that may be associated with differences in conservatism. Similar conclusions arise from tests that use alternative measures of the economic bond between auditors and their clients, as well as in tests confined to either the Big 6 or non‐Big 6 audit firms. Our results are consistent with factors such as market‐based incentives, the threat of litigation, and alternative governance mechanisms offsetting any expected benefits to the audit firm from reducing its independence. We therefore conclude that recent legislative intervention aimed at restricting the supply of NAS is unlikely to result in increased independence in fact, although independence in appearance may be improved.

Takeover Premiums and the Perception of Auditor Independence and Reputation

“…On average, NAS fees are 34% of the total fee received by the target firm auditor. This statistic is slightly higher than the ratio of 29% reported in the Australian study by Ruddock, Taylor and Taylor (2006). The statistics for RNASAUD indicate that the average fee paid for NAS is approximately equal to the audit fee, raising the possibility that financial statement users may perceive an impairment of audit independence.…”

“…Kinney, Palmrose and Scholz (2004) examine the association between financial report restatements and NAS fees and document a positive relationship only for unspecified NAS fees. Ruddock, Taylor and Taylor (2006) show that NAS fees are unrelated to earnings conservatism.…”

Do the organization types of audit firms matter to earnings conservatism? Evidence from China

“…Interpretation of the results is dependent on the earnings-return relation (Dietrick et al, 2002), indicating that market return is a timely reflection of news for less accounting conservatism (Givoly and Hemmer, 2001;Ruddock et al, 2006). Hence, this study also examines a time series measure of earnings and time series relation between accruals and operating cash flow.…”

“…Ruddock et al (2006) suggest that the state law enables audit firms practice under either unlimited or limited liability (LL) organizational forms and many audit firms tend to converted to LL forms (Muzatko et al, 2004). By late 1994, all Big 6 audit firms converted from general partnerships (GP) to limited liabilities partnerships (LLPs).…”

Introduction to Thematic Symposium on Accounting Professionalism

“…The fourth paper is presented by Mescall et al (2016) who investigate the link between observable signals of possible impairments of public accountant independence (e.g., Ye et al 2011) and the impact of firms' commercial dependence on clients (e.g., Li 2009; Ruddock et al 2006). The authors compare sanctions imposed on auditors before and after the creation of the Canadian Public Accountability Board (CPAB) in 2003.…”