Auditor independence and non-audit services - ICAEW

lockholder 10 ownership. In contrast to Parkash and Venable (1993) and Firth(1997a), leverage (a proxy for high agency costs) was not found to be significant.The study by Houghton and Jubb (1999) looks beyond the issuance of a qualifiedaudit report to investigate whether this event impacts upon the subsequent purchase ofNAS from the incumbent auditor. They find that the amount of services purchasedincreases.Finally, Chen, Krishnan and Su (2002) also introduce a new explanatory variable intothe NAS purchase decision model, exploring the impact of managers’ compensationstructure. Thus their focus is on the ‘benefit’ rather than the ‘cost’ side of the NASpurchase decision. Their argument is that NAS purchases impact favourably on firmperformance and so enhance managers’ performance-related compensation. They finda positive association between NAS purchases and the proportion of compensationthat is performance based. Moreover, this association is stronger for companies with alarger investment opportunity set (intangible assets). Such companies are more likelyto gain from auditors’ expertise in identifying and exploiting growth opportunities.6.3 Summary and commentThis first thing to note about several of the studies above is that the need to collect feedata via questionnaire in many jurisdictions means that the samples used by thesestudies may be either unrepresentative of the population (given that response rates inthe region of 30% are typical) or, at worst, systematically biased.The NAS purchase decision, in particular the amount of NAS fees paid to theincumbent auditor relative to audit fees has been explained in terms of agency-relatedvariables, the characteristics of the audit committee and the form of managementcompensation. Studies show that, in general, and consistent with expectations,companies with higher agency costs, more effective audit committees and a lowerproportion of performance-based management compensation have lower NAS feeratios. The overall explanatory power of these models is, however, low, the amount ofvariation being explained is in the region of 10-20%. It may be that factors that aresystematically related to the purchase decision have been omitted and/or the decisionhas inherently random elements.10 Blockholdings relate to concentrated ownership, the argument being that a significant investment byan outside owner will provide incentives for direct monitoring, thus reducing the demand for auditormonitoring.33