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    Do Former Audit Firm Partners on Audit Committees Procure...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 13.0 Governance, 13.01 Board/Audit Committee Composition 
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    Title:
    Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor?
    Practical Implications:

    This study presents new evidence that suggests the presence of AFAPs and UFAPs on the audit committee has the potential to reduce threats to auditor independence by pre-approving the purchase of less NAS form the auditor. The findings of this study are consistent with the view that AFAPs serving as independent audit committee members appear not to make economic decisions in favor of their former audit firm, and, thus, may be exercising objective and independent oversight to enhance auditor independence. This evidence is also in line with the goal of SOX to reduce actual or perceived threats to auditor independence. From a regulatory perspective, the findings suggests that concerns about audit firm alumni on client’s audit committees may not be warranted in the post-SOX environment and the three-year cooling period rule may be unnecessary. However, further research in other contexts is needed.

    For more information on this study, please contact Vic Naiker.
     

    Citation:

    Naiker, V., D. S. Sharma, and V. D. Sharma. 2013. Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor? The Accounting Review 88 (1): 297–326.

    Keywords:
    alumni; audit committee; cooling-off period; former partner; independence; nonaudit; revolving-door
    Purpose of the Study:

    This study focuses on how the presence of a former audit firm partner (FAP) on the audit committee is related to nonaudit services (NAS) procured from the external auditor. The Sarbanes-Oxley Act of 2002 requires the audit committee to pre-approve nonaudit services procured from the auditor to prevent potential independence issues. The presence of a FAP affiliated with the current auditor on the audit committee could undermine the audit committee’s due diligence over the NAS pre-approval process. To alleviate these concerns, the SEC implemented a three-year cooling-off period for appointing audit form alumni as independent directors. This study analyzes the effects of these relationships on auditor independence.

    Design/Method/ Approach:

    A sample of 2,748 firm-year observations with available corporate governance, director, and CFO biographical data for fiscal years ending in 2004 and 2005 was selected. The sample was tested using regression models to investigate the association between affiliated former audit partners (AFAPs) and unaffiliated audit partners (UFAPs) on the audit committee and nonaudit services purchased from the auditor.

    Findings:
    • Firms with FAPs purchase significantly less NAS compared to firms without and FAP.
    • The capacity of the audit committee to reduce dependency on auditor-provided NAS in the post-SOX era may be enhanced when committee members possess partner-level experience.
    • AFAPs on the audit committee adopt a more conservative NAS pre-approval strategy by reducing NAS purchased from the auditor.
    • Audit committees including AFAPs not meeting the mandatory three-year cooling off periods are equally conservative when pre-approving NAS purchased for the auditor relative to audit committees that include AFAPs satisfying this rule and UFAPs.
       
    Category:
    Governance, Independence & Ethics, Standard Setting
    Sub-category:
    Board/Audit Committee Composition, Impact of SOX, Non-audit Services