Auditor independence and non-audit services - ICAEW

characteristics of clients who seek NAS, or it may be auditors seeking to extract feepremia beyond the additional effort required. While the former is unlikely tocompromise independence, the latter is.Using data from 336 bids, it is found that the firm plans more effort for clientspurchasing additional services. There is no evidence that NAS clients have additionalproblems (i.e., are systematically riskier) that might lead the firm to plan more effortor seek a higher fee. There is, however, evidence of greater use of industry experts,which may imply the assignment of engagement personnel who can better integratethe multiple services provided. The firm proposes a small but significant fee premiumafter controlling for the incremental effort, however an analysis of accepted versusrejected bids shows that this fee premium is bid away in the market.Johnstone and Bedard’s explanation for these results is that the firm sees thepossibility of increased quality through synergy across services and sets bid pricesaccordingly. They conclude that the incremental effort applied, use of more industryspecialists and attempts to charge a fee premium (and not a discount) are inconsistentwith the SEC’s concerns regarding the impact of joint NAS provision on audit quality.8.6 LowballingMany studies consider the impact of an auditor change on audit fees. The reductionthat is normally observed 24 is considered potentially undesirable insofar as it maysignal that the fee charged is below cost. This is felt to undermine audit quality in thelong-run. Various terms have been used in relation to fee reductions associated withauditor changes: ‘lowballing’, ‘predatory pricing’, and ‘fee discounting’. In thepresence of joint service provision, the concern is that there is cross-subsidisation,with audit being a loss-leader.Regression studies of audit pricing in initial engagements do not all consider theimpact of NAS provision by the auditor. Of the studies included in footnote 24, onlyTurpen (1990) includes NAS fees as a control variable in estimating a model of auditfees for initial engagements, finding a positive relationship. In other words, initialaudit fees are higher in the presence of NAS provision by the auditor.In the UK, McMeeking (2001) considers the association between audit and non-auditfees following a change of auditor. The model simultaneously tests for evidence of feecutting, cross-subsidisation, loss leader pricing and knowledge spillovers. Using datafrom 1992-1995 for the top 350 listed companies, he finds that changes in audit feesare negatively associated with the change in non-audit fees conditional on a change ofauditor dummy variable. Although the coefficients on these variables are notstatistically different from zero, McMeeking interprets this finding as indicative thatboth audit and non-audit fees are cut following a switch.23 Archival research is research based on publicly available data.24 See, for example, Simon and Francis (1988), who observe an average price cut of 24%; Turpen(1990) who observes an average price cut of 19%; Ettredge and Greenberg (1990), who observe anaverage price cut of 25%; Gregory and Collier (1996) (a UK study), who observe an average price cutof 22%; and Craswell and Francis (1999), who observe an average price cut of 30% from non-Big 8 toBig 8 auditors.51