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    The Impact of Nonaudit Service Fee Levels on Investors’ P...
    research summary posted May 7, 2012 by The Auditing Section, last edited May 25, 2012, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services 
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    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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