Auditor independence and non-audit services - ICAEW

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within the system), suggesting that the levels of the two services are jointlydetermined. This introduces simultaneous-equations bias into the estimations, andconsequently the results of such studies are unreliable. Using single-equation auditand non-audit fee models, they replicate the positive association between audit andnon-audit fees found in most prior studies. However, using a simultaneous-equationmodel (which controls for the simultaneous bias), it is found that joint provision leadsto lower audit fees (as might intuitively be expected if knowledge flows from nonauditto audit and results in cost savings for the auditor). Moreover, the size of theimpact is economically significant – every 1% increase in NAS fees is associated witha 0.33% reduction in audit fee.8.4.3 UK studiesNAS fees is the variable of interest in Ezzamel, Gwilliam and Holland’s (1996) studybased on data from 314 UK quoted companies. They find a significant positiveassociation between audit and non-audit fees similar to that found in prior US andAustralian studies. They explore the nature of this relationship by examining theinteraction between NAS and other factors that appear to affect audit pricing.Nine interaction terms (these are additional independent variables created bymultiplying NAS fees by one of the other independent variables) are introduced intothe model. Four are found to be significant, suggesting that NAS fees may moderatethe association between other independent variables and audit fees. Specifically, whenNAS is combined with two complexity variables, a Big Six dummy variable 21 and aregulated industry dummy variable, significant negative relationships emerge. Thismeans that Big Six auditees and companies operating in a regulated industry havelower fees, after controlling for other determinants of audit fees.O’Sullivan and Diacon (1996) look at fees in the UK insurance industry, a sector ofthe market where customer and ownership interests merge. NAS fees is one of thevariables of interest. A significant positive association is found, i.e. higher NAS feesare associated with higher audit fees.Beattie, Goodacre, Pratt and Stevenson (2001) explore audit fee determinants in thevoluntary sector using data from 210 top UK charities. This is a market where the BigSix do not dominate to the same degree as in the listed private sector. This study toodocuments a significant positive association between audit and non-audit fees paid tothe auditor.McMeeking, Pope and Peasnell (2002), using data for nearly 500 companies from1992-1995, estimate a simultaneous-equation model of knowledge spillovers, similarto Whisenant et al. (2002). The model estimates reveal a positive relationship betweenaudit and non-audit fees. This is interpreted as implying that the Big Six premium isdriven by endogeneity between audit and non-audit fees, that firms use joint productpricing strategies and that client companies will pay a premium for the provision ofNAS.21 Dummy variables are used in regression analysis to capture possible explanatory (i.e., independent)variables that consist of two categories, such as Big Six auditor or not. The dummy variable is set to thevalue of 1 for Big Six auditors are 0 otherwise.49
Ezzamel, Gwilliam and Holland (2002) make use of survey-sourced data regardingtypes of NAS provided by the auditor to explore the link between NAS and audit fees.They distinguish five categories of service: accounting-related; finance-related; taxrelated;management consultancy; and other. They find a significant positiveassociation with audit fees for tax and corporate finance services, but no significantassociation for the other three categories of service. None of the service categoriesprovided by non-incumbent auditors was associated with audit fees, nor was theexistence of an internal audit function. The authors conclude that their evidencesuggests that the positive link between NAS and audit fees is due to client-specificdifferences, rather than an economic link between the cost functions for NAS andaudit.8.4.4 Norwegian studiesFirth (1997b) finds a significant positive association between audit and NAS fees paidto the incumbent auditor, based on data for 157 listed companies for 1991 and 1992.This was a time when new regulation requiring disclosure of NAS fees paid to theauditor had just become effective.8.4.5 Australian studiesBarkess and Simnett (1994) find a significant positive relationship between fees paidto the auditor for other services and audit fees. In their study, NAS fees paid to theauditor is the dependent variable; it is more usual for NAS fees to be an independentvariable in an audit fee model.Butterworth and Houghton (1995) include NAS fees as a control 22 variable in a pricecuttingstudy, finding a significant positive association with audit fees. Jubb,Houghton and Butterworth (1996) include NAS fees as a control variable in a studyfocusing on the nature of risk in audit fee determinant studies. A significant positiverelationship is found based on data from over 200 publicly listed Western Australiancompanies.8.5 Audit effortDavis, Ricchiute and Trompeter (1993) use a different method of investigation. Theyobtain private, internal data from an audit firm (audit hour and billing rate) that allowsthem to undertake a more direct (and hence more powerful) test for knowledgespillovers. They show that increased audit effort (rather than economies of scope) canexplain the increased audit fee associated with the provision of NAS by the auditor. Itfollows that the increased audit fees observed in the presence of joint NAS provisiondo not constitute an enhanced incentive for the auditor to compromise theirindependence.Johnstone and Bedard (2001) obtain proprietary data from an audit firm regardingengagement planning and bid pricing for a set of initial engagement proposals that asingle firm submitted to its prospective clients in 1997-98. The objective is toexamine the influence of client risk factors and NAS provision. The authors note thatthe positive association between audit and NAS fees found by most archivalresearch 23 may result from additional effort required, due to the different22 Control variables are independent (i.e., explanatory) variables that are not the variable of key interest.To investigate the variable of interest it is necessary to include other correlated explanatory variables inregression models if the model is to be well-specified and produce reliable results.50
Page 5 and 6:
LIST OF TABLESPage3.1 Definitions a
Page 7 and 8:
LIST OF ABBREVIATIONSACCAAICPAAPBAR
Page 9 and 10:
Auditor Independence and Non-audit
Page 11 and 12: 2.2 Current regulatory frameworks:
Page 13 and 14: There is limited evidence that, in
Page 15 and 16: firms have, over the last 10 years,
Page 17 and 18: CHAPTER 2AUDITOR INDEPENDENCE2.1 In
Page 19 and 20: low cost strategies to protect and/
Page 21 and 22: • the costs of auditor switching
Page 23 and 24: Johnstone, Sutton and Warfield (200
Page 25 and 26: estrictive. Nevertheless, these stu
Page 27 and 28: 3.3 Independence in professional an
Page 29 and 30: Table 3.1 (cont.): Definitions and
Page 31 and 32: followed by a detailed set of rules
Page 33 and 34: Provision of some of these services
Page 35 and 36: There is a significant self-review
Page 37 and 38: of taking management decisions, sel
Page 39 and 40: pieces. While a few research-relate
Page 41 and 42: CHAPTER 5DESCRIPTIVE STUDIES OF NAT
Page 43 and 44: Ezzamel, Gwilliam and Holland (2002
Page 45 and 46: Parkash and Venable’s (1993) stud
Page 47 and 48: CHAPTER 7IMPACT OF JOINT PROVISION
Page 49 and 50: affirmative to five type of service
Page 51 and 52: McKinley, Pany and Reckers (1985) u
Page 53 and 54: NAS and audit fees regardless of th
Page 55 and 56: 7.3.5 New Zealand studiesGul (1989)
Page 57 and 58: support those of Corless and Parker
Page 59 and 60: CHAPTER 8ASSOCIATIONS BETWEEN JOINT
Page 61: an independent variable in the audi
Page 65 and 66: 8.7 Auditor tenure and auditor chan
Page 67 and 68: CHAPTER 9EVIDENCE OF ASSOCIATION BE
Page 69 and 70: CHAPTER 10EVIDENCE OF ASSOCIATION B
Page 71 and 72: 10.3.3 Australian studiesGul and Ts
Page 73 and 74: the frameworks are generally imprec
Page 75 and 76: publicly available data of relevanc
Page 77 and 78: Antle, R. and Demski, J.S. (1991),
Page 79 and 80: Craswell, A.T., Stokes, D.J. and La
Page 81 and 82: Frankel, R.M., Johnson, M.F. and Ne
Page 83 and 84: Jeppesen, K.K. (1998), ‘Reinventi
Page 85 and 86: O’Sullivan, N. and Diacon, S.R. (
Page 87 and 88: Schuetze, W.P. (1994), ‘A Mountai
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Auditor independence and non-audit services - ICAEW

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