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    How Increased Regulatory Oversight of Nonaudit Services...
    research summary posted May 28, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services 
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    Title:
    How Increased Regulatory Oversight of Nonaudit Services Affects Investors’ Perceptions of Earnings Quality
    Practical Implications:

    Although the findings of this study provide evidence of investor perceptions of NAS and of how these perceptions are conditional on regulations and audit quality, the results, and their implications for policy should be viewed with caution. These results are based on Norwegian data and a distinctive regulatory environment. The authors examined a period when a series of high-profile accounting scandals hit in Europe and the U.S., which may have also influenced investors’ earning quality perceptions. This study, however, reveals many possibilities for new research to better determine how regulations affect investor perceptions of NAS. 

    Citation:

    Eilifsen, A., and K. H. Knivsflå. 2013. How Increased Regulatory Oversight of Nonaudit Services Affects Investors’ Perceptions of Earnings Quality. Auditing 32 (1).

    Keywords:
    audit firm quality; earnings response coefficients; investor perceptions; nonaudit services; regulation
    Purpose of the Study:

    Investor confidence in financial statements and the audit process are often contingent on auditor independence. One of the most debated threats to auditor independence arises from economic bonds between auditors and clients stemming from the joint provision of audit and nonaudit services (NAS). Researchers have long sought to establish how the economic bonds between auditors and clients, arising from the provisions of NAS, affect auditor independence. In 2003, The Financial Supervisory Authority of Norway (FSA) disclosed that audit firms had violated the legal restrictions for providing NAS. In response, the FSA tightened NSA regulations. This study examines how regulatory oversight affects the relation between the provision of NAS and earnings response coefficients (ERC). 

    Design/Method/ Approach:

    The authors first developed two hypotheses for testing:

    H1: For low-quality audit firms, the association between the level of NAS and investors’ perceived earnings quality was negatively affected after the disclosure of NAS regulation violations in 2003. The effect is more negative in the disclosure year 2003 that in the new regulation period 2004-2008. 

    H2: Higher-quality audit firms moderate the negative effects associated with low-quality audit firms in H1.

    To test H1 and H2, the authors use the ERC from earnings-response regression models as a proxy for investor perceptions of earnings quality. Essentially, the ERC is the estimated effect of reported earnings or change in earnings on stock prices, stock returns, or abnormal stock returns. The sample consists of companies listed on the Oslo Stock Exchange (OSE). The final sample consists of 1,646 company-year observations for 293 individual companies for the ten-year period from 1999-2008. 

    Findings:
    • For small, non-industry specialized audit firms, the relationship between NAS and ERC is negatively affected after the 2003 disclosure of the audit firms’ violations of the legal NAS restrictions and is more negatively affected in the disclosure year 2003 than in the new regulation period 2004-2008.
    • For Big 5 firms, audit quality moderates the negative effects on investor perceptions that were associated with low-quality audit firms in 2003 and 2004-2008.
    • Industry specialization among audit firms amplifies investor concerns regarding auditor independence in 2003. 
    • Investors react negatively to the disclosure of NAS violations and new regulations ease investor concern. 
    Category:
    Independence & Ethics
    Sub-category:
    Non-audit Services
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