Auditor independence and non-audit services - ICAEW

Parkash and Venable’s (1993) study is grounded explicitly in agency theory. Theydistinguish between recurring and non-recurring NAS, and focus only on the levelspurchased from the incumbent auditor. It is argued that a significant perceivedimpairment of independence will occur only in the case of recurring NAS, which haveassociated future quasi-rents. It is therefore expected that firms with higher agencycosts, which have greater need of independent audits, will acquire less recurring NASfrom the company’s auditor. This expectation is supported.Firth (1997a) also uses agency theory to try to explain the decision to purchase NASfrom the incumbent auditor. He makes use of the UK requirement to disclose NASfees paid to incumbent auditors. UK disclosures do not require a distinction to bemade between recurring and non-recurring fees. However Firth points out that such agrouping is subjective and that continuing non-recurring fees would probably impairindependence to the same extent as those classified as recurring (p.19). Firth findsthat, as hypothesised, higher agency costs (proxied by director shareholdings, largeshareholdings and financial distress) are associated with lower relative levels of NASpurchases from the incumbent.Abbott, Parker, Peters and Raghunandan (2001) make use of the new SECrequirement for companies to disclose, in their proxy statements, both audit and nonauditfees paid to the auditor (SEC, 2000). They extend previous agency studies andexamine the association between audit committee characteristics and the relativemagnitude of NAS purchased from the incumbent auditor. Audit committees are animportant corporate governance mechanism and mediate the auditor-clientrelationship. In response to the Blue Ribbon Committee on Improving theEffectiveness of Corporate Audit Committees (1999), the SEC now requires that auditcommittees consider all relationships between the auditor and the company anddisclose that the impact of all relationships on auditor independence has beendiscussed with the auditor. This latter requirement implies that the audit committeehas decision rights in the NAS purchase decision.Abbott et al. (2001) hypothesise that independent and active audit committees, whoare likely to be more pro-active in their oversight activities, will act to limit therelative amount of NAS purchased from the incumbent auditor. Their sample consistsof 262 companies filing during a seven-week period in early 2001. This study is oneof the first to examine the pricing effects of joint provision in the current US auditenvironment, characterised by changed audit technologies and an expanded market forNAS. They estimate a regression model of the NAS to audit fee ratio that includesaudit committee variables as independent variables. Results indicate that companieswith audit committees that consist solely of independent directors and that meet atleast four times a year are likely to have lower fee ratios. This suggests that auditcommittee members perceive a high fee ratio in a negative light (related to either thefact or appearance of independence) and take steps to reduce it.They also find that fee ratios are higher for larger companies and for clients of Big 5auditors, while fee ratios are lower for firms with higher levels or outside32