The relationship between non-audit fees and audit quality: dealing with the endogeneity issue

Abstract

Purpose

The purpose of this paper is to explore whether the provision of non-audit services (NAS) by public accounting firms undermines audit quality. The study addresses this question by testing for an association between the provision of consulting services and auditor independence in listed companies.

Design/methodology/approach

The authors study if the magnitude of non-audit fees explains variations in earnings management by looking at the joint determination of non-audit fees, audit fees, and abnormal accruals using the SURE-regression estimation method.

Findings

Evidence from tested models suggests that audit services quality is uncompromised by the provision of NAS. In other words, high non-audit fees do not necessarily result in poor quality financial reporting.

Research limitations/implications

A different research methodology and a different sample (e.g. non-listed companies) may lead to differing results. As the paper analyses only one country, generalizability of the results might be a limitation. There is no need to increase legal restrictions on the provision of consulting services by public accounting firms in order to better safeguard audit quality.

Practical implications

Consulting clients may be more confident to hire both audit and NAS with the same firm and can make a case before the general Shareholders’ meeting. By providing both audit and NAS, consulting firms obtain knowledge spillovers and synergies while appealing highly qualified professionals.

Originality/value

The use of simultaneous equations (SURE-regression) to establish the auditor-client relation allows us to better model theoretical relations between audit fees, non-audit fees, and abnormal accruals. Likewise, joint modeling takes account of correlations between the error terms of the individual models, yielding more efficient estimates than ordinary least squares. Performing this analysis in a non-Anglo-American country with low litigation risk is also a valuable contribution to extant literature.

Citation

Carmona, P., Momparler, A. and Lassala, C. (2015), "The relationship between non-audit fees and audit quality: dealing with the endogeneity issue", Journal of Service Theory and Practice, Vol. 25 No. 6, pp. 777-795. https://doi.org/10.1108/JSTP-07-2014-0163