Accepted by Dan Simunic. An earlier version of this paper was presented at the 2004 Contemporary Accounting Research Conference, generously supported by the Canadian Institute of Chartered Accountants and Ordre des comptables agréés du Québec. We acknowledge financial support from an Australian Technology Network Research Grant and the Co-Operative Research Centre for Technology Enabled Capital Markets (Capital Markets CRC Ltd.). We appreciate the com-ments and suggestions of Sudipta Basu, Jeff Coulton, Allen Craswell, Patricia Dechow, Jennifer Francis, Jere Francis, Zoltan Matolcsy, Karen Nelson, Susan Parker, Scott Richardson, Katherine Schipper, Dan Simunic, Donald Stokes, Ross Watts, and two anonymous referees; as well as attendees at the 2002 University of Technology Sydney (UTS) Summer Research School, 2002 International Symposium on Audit Research, 2002 Accounting Association of Australia and New Zealand (AAANZ) annual conference, 2003 American Accounting Association (AAA) Auditing mid-year conference, 2003 AAA annual conference, 2004 Hong Kong University of Science and Technology Summer Symposium, and 2004 CAR Conference; and workshop participants at the following universities: Adelaide, Melbourne, Monash, New South Wales, and Queensland University of Technology.
Nonaudit Services and Earnings Conservatism: Is Auditor Independence Impaired?*
Article first published online: 15 JAN 2010
2006 Canadian Academic Accounting Association
Contemporary Accounting Research
Volume 23, Issue 3, pages 701–746, Fall 2006
How to Cite
Ruddock, C., Taylor, S. J. and Taylor, S. L. (2006), Nonaudit Services and Earnings Conservatism: Is Auditor Independence Impaired?. Contemporary Accounting Research, 23: 701–746. doi: 10.1506/6AE8-75YW-8NVW-V8GK
- Issue published online: 15 JAN 2010
- Article first published online: 15 JAN 2010
- Audit quality;
- Auditor independence;
- Nonaudit services
We examine whether the provision of nonaudit services (NAS) by incumbent auditors is associated with a reduction in the extent to which earnings reflect bad news on a timely basis (that is, news-based conservatism). Reduced conservatism is expected to occur if relatively high levels of NAS result in reduced auditor independence and, ultimately, lower-quality auditing. Because client-specific demand for NAS is expected to vary, our proxy for the auditor-client economic bond is the extent to which NAS purchases (relative to audit fees) are greater or less than expected. Using several different methods for identifying news-based conservatism, we consistently find that higher than expected levels of NAS are not associated with reduced conservatism. This result is robust to allowing for endogenous NAS demand, as well as several explicit factors that may be associated with differences in conservatism. Similar conclusions arise from tests that use alternative measures of the economic bond between auditors and their clients, as well as in tests confined to either the Big 6 or non-Big 6 audit firms. Our results are consistent with factors such as market-based incentives, the threat of litigation, and alternative governance mechanisms offsetting any expected benefits to the audit firm from reducing its independence. We therefore conclude that recent legislative intervention aimed at restricting the supply of NAS is unlikely to result in increased independence in fact, although independence in appearance may be improved.