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  • The Auditing Section
    The Impact of Nonaudit Service Fee Levels on Investors’ P...
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services 
    Title:
    The Impact of Nonaudit Service Fee Levels on Investors’ Perception of Auditor Independence
    Practical Implications:

    The results of this study are important to both investors and regulators.  For investors, the results may highlight that, despite the presence of non-audit fees, it is possible that the audit firm may be independent in fact.  For standard setters, the study sheds some light on how the public perception of the external auditor as an independent professional, given the levels of nonaudit fees, plays a vital role in the success of the financial markets even when the auditor is independent in fact.  The study also has implications to auditors and clients who might be motivated to change the levels of nonaudit services and/or fees given investors’ negative reactions to them. 

    Citation:

    Davis, S. M. and D. Hollie. 2008. The Impact of Nonaudit Service Fee Levels on Investors’ Perception of Auditor Independence. Behavioral Research in Accounting 20 (1): 31-44.

    Keywords:
    auditor independence; nonaudit fee ratios; disclosure; investor perception; market efficiency
    Purpose of the Study:

    Since the passage of the Sarbanes-Oxley Act of 2002 there has been a substantial increase in the level of scrutiny over auditor independence. Specifically, one of the provisions of the legislation prohibits audit firms from providing certain non-audit services to their audit clients. The main purpose of this provision is to increase investor perception of auditor independence by reducing the potential conflicts of interest between auditors and their clients.  Prior research on the impact of nonaudit services fees on the appearance of auditor independence has produced mixed findings.  However, prior research has not focused on the level of fee ratios (nonaudit fees to total fees).  The current study examines the effects of non-audit fee ratios on investor perception of auditor independence and on market behavior.  Below are the specific objectives that the authors address in their study: 

    • Examine the effect of various fee ratios (nonaudit fees to total fees) on investors’ assessment of auditor independence and market outcomes.
    • Examine whether investor perception of auditor independence differs as the fee ratio increases.
    • Examine whether investor’s pricing errors (i.e., the price paid less the stated value) increase as the fee ratio increases. 
    Design/Method/ Approach:

    The authors collected their evidence via an investor trading experiment involving 48 MBA students.  Participants are assigned the role of an investor and are provided with an auditor’s report detailing an estimate of the value of an asset in question, as well as a ratio of their non-audit fees compared to total audit fees.  The nonaudit fee ratio varies across participants and is either 0, 25, 50, or 75 percent.  Investors read a statement explaining SEC concerns about non-audit fees and then make a judgment about their belief that the auditor is biased/unbiased and an indication of their confidence level in this judgment. Investors then provide a best estimate of their belief of the asset value and begin trading shares of the company. Data collection was performed prior to 2008.

    Findings:
    • The disclosure of nonaudit fees reduces the accuracy of investor perception of auditor independence.
    • Even when the auditor is independent in fact, investors perceive that independence is compromised when nonaudit fees are disclosed.
    • The magnitude of nonaudit fees to total fees matters.  Investors are more inclined to perceive that independence is impaired as the fee ratio increases.
    • Investors have higher asset pricing errors, thus, lower market efficiency, as the fee ratio increases.
    • Investor perceptions of auditor independence decline and market outcomes are less efficient as the nonaudit fee ratio increases (i.e., from 0% to 25% to 50%), but both become constant when the level of nonaudit fees equals or exceeds total fees (i.e., at the 50% and 75% ratio). 
    Category:
    Independence & Ethics
    Sub-category:
    Non-audit Services
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  • Jennifer M Mueller-Phillips
    The Role of Auditors, Non-Auditors, and Internal Tax...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services 
    Title:
    The Role of Auditors, Non-Auditors, and Internal Tax Departments in Corporate Tax Aggressiveness.
    Practical Implications:

    The results of this study are important to policymakers as the PCAOB considers whether tax and audit services should be provided by different firms. The results of this study indicate that auditor-provided tax services may actually decrease the tax aggressiveness of companies, especially those serviced by the Big 4. Based on the representative who signs the tax return, tax aggressiveness is higher for internally prepared and non-auditor externally prepared tax returns than auditor-prepared tax returns. Additionally, accounting professionals may be interested in the findings of this study as it provides insights into how tax compliance changes in the presence of an audit. The authors suggest that signing a tax return with aggressive positions is costly to auditors because of reputation risk and financial reporting restatement risk in the tax accounts. As accounting professionals seek to perform effective audits and accurate tax returns, it may be beneficial to consider how tax compliance decisions could be impacted by the same firm providing both services.

    Citation:

    Klassen K. J., P. Lisowsky, and D. Mescall. 2016. The role of auditors, non-auditors, and internal tax departments in corporate tax aggressiveness. The Accounting Review. 91(1): 179-205.

    Keywords:
    tax preparer, auditor, tax fee, FIN 48, tax aggressiveness
    Purpose of the Study:

    Corporate tax returns may be prepared by management, an external party who does not perform the audit, or the company’s auditor. There is little evidence to suggest how the type of tax preparer impacts corporate tax decisions. In particular, it is unclear how the dual role of auditor-tax preparer may impact tax compliance outcomes. This study seeks to provide insight into how tax preparer type influences corporate tax aggressiveness. Specifically, the authors:

    • Examine the relationship between the tax return preparer type and corporation tax aggressiveness. 
    • Examine whether tax fees as a representation of tax planning supports the findings of prior academic research.
    • Examine the link between tax aggressiveness and tax preparer type for Big 4 firms.
    Design/Method/ Approach:

    The authors were able to obtain confidential data from the Internal Revenue Service (IRS) for 2008 and 2009. The data provided by the IRS Large Business & International Division included tax return preparer identities and FIN 48 disclosures. Financial statement data were obtained from Compustat, and auditor identity, tax fees, and audit fees were obtained from the Audit Analytics database. The authors proxy for tax aggressiveness using the current-year increase in the tax reserve from FIN 48 disclosures on each company’s tax return. They use the tax return preparer identities in combination with the auditor identities to identify the tax return preparer type for their analysis. Based on the availability of the data, the final sample consisted of 1,533 firm-years (804 firms in 2008 and 729 in 2009).

    Findings:
    • The authors find that tax returns that are internally prepared by management claim more aggressive tax positions than auditor-prepared returns. Tax returns that are prepared by a non-auditor external party also claim more aggressive tax positions than auditor-prepared returns.
    • The authors find that less tax aggressiveness occurs for clients when the tax preparer is also the auditor and a Big 4 firm than when the tax preparer and auditor are different Big 4 firms.
    • The authors corroborate prior academic research that suggests tax fees represent the level of tax planning by the audit firm. The authors find that even after considering the tax return preparer type which accounts for tax compliance costs, higher tax fees paid to the auditor are indicative of more tax aggressive behavior.
    Category:
    Independence & Ethics
    Sub-category:
    Non-audit Services
  • Jennifer M Mueller-Phillips
    Threats to Auditor Independence: The Impact of Relationship...
    research summary posted December 3, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    Threats to Auditor Independence: The Impact of Relationship and Economic Bonds
    Practical Implications:

    The results of the study suggest that establishing close auditor-client relationships can reward audit firms with higher NAS revenues from clients. In particular, longer audit firm tenure and audit firm alumni directors benefit the audit firms with higher NAS provision. This indicates that a successful strategy for audit firms may be to develop long-term associations with clients at the firm level (rather than at the partner level) and to establish active alumni networks. At the same time audit firms should ensure that adequate procedures are in place to ensure that appropriate audit reports are issued, most particularly when strong auditor-client relationships are present.

    For more information on this study, please contact Elizabeth Carson.

    Citation:

    Ye, P., E. Carson, and R. Simnett. 2011. Threats to auditor independence: The impact of relationship and economic bonds. Auditing: A Journal of Practice & Theory 30 (1): 121-148.

    Keywords:
    Independence and ethics; non-audit services; going concern decisions; alumni
    Purpose of the Study:

    Auditor independence is the foundation of high quality audit services and a crucial component in the statutory corporate reporting process. The cases of high-profile corporate failure associated with auditing scandals in early 2000s have cast doubts over auditor independence and the value of auditing. Most regulatory concerns regarding auditor independence have centered on three alleged independence threats:

    • Auditor’s economic dependence on the client due to the provision of non-audit services (NAS)
    • Auditor’s familiarity with the client due to lengthy audit tenure
    • The personal relationships between the audit engagement partner and client’s directors

    Relevant regulatory reforms have taken place in both the U.S. (SOX, 2002) and Australia (CLERP 9, 2004) to mitigate such concerns. However, empirical evidence only provides limited support to the regulations, and two fundamental questions underlying the independence issue remain unanswered:

    • What factors influence a company’s decision to purchase NAS from its incumbent auditor?
    • How do the economic and social bonds between auditors and clients affect auditor independence?

    This paper addresses the questions to inform regulation by examining:

    • Whether client’s NAS purchase from the incumbent auditor is affected by four identified auditor-client relationships: (1) audit firm tenure, (2) audit partner tenure, (3) relationship tenure (ongoing personal interactions between audit engagement partner and client’s director), and (4) client’s director being an alumnus of the audit firm. 
    • Whether auditor’s propensity to issue a going-concern opinion (as the manifestation of auditor independence) is affected by the provision of NAS and the four identified auditor-client relationships.
    Design/Method/ Approach:

    The study uses 2002 Australian data on publicly-traded companies. 2002 is chosen as a period when the audit environment was still relatively unregulated. Data was hand-collected from companies’ annual reports. The impacts of various factors on auditor independence are examined using statistical analysis.

    Findings:

    The study finds:

    • Some evidence that increased audit firm tenure and the presence of directors with alumni connections to the incumbent audit firm is associated with an increased likelihood of clients’ NAS purchase from the incumbent audit firm. Such impact is stronger in companies with lower leverage and higher ownership concentration.
    • No evidence that audit partner tenure or relationship tenure (between audit partner and client director) impacts client’s NAS purchasing decisions.
    • Evidence that higher levels of NAS provision and longer audit partner tenure are associated with a lower propensity in auditor’s issuance of going-concern opinions.
    • No evidence that audit firm tenure, relationship tenure or the presence of client director’s alumnus status impacts on auditor’s propensity to issue going-concern opinions.
    • Evidence that auditors are less likely to issue a going-concern opinion when there is a high-level NAS provision to the client and the client has an incumbent audit firm alumni director.
    Category:
    Auditor Judgment, Independence & Ethics
    Sub-category:
    Going Concern Decisions, Non-audit Services

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