Auditor Fees and Fraud Firms

Abstract

The issue of whether auditor fees affect auditor independence has been extensively debated by regulators, investors, investment professionals, auditors, and researchers. The revised Securities and Exchange Commission (SEC) requirements that resulted from the implementation of the Sarbanes‐Oxley Act (2002) limit nonaudit services (NAS) and mandate NAS fee disclosure. The SEC's requirements are based on the argument that auditor independence could be impaired—and hence audit quality may be reduced—when auditors become economically dependent on their clients or audit their own work. Economic bonding leads to reduced independence, which can lead to reduced audit quality. We study a sample of firms sanctioned by the SEC for fraudulent financial reporting in Accounting and Auditing Enforcement Releases (SEC‐sanctioned fraud firms) and examine whether there is a relationship between auditor fee variables and the likelihood of being sanctioned by the SEC for fraud. We use SEC sanction as a measure of audit quality that has not previously been used in the auditor fee literature and is more precise than some of the other proxies used for flawed financial/auditor reporting. We find, in univariate tests, that fraud firms paid significantly higher (total, audit, and NAS) fees. However, in multivariate tests, when controlling for other fraud determinants and endogeneity among the fraud, NAS, and audit fee variables, we find that while NAS fees and total fees are positively and significantly related to the likelihood of being sanctioned by the SEC for fraud, audit fees are not. These findings suggest that higher NAS fees may cause economic bonding, thereby leading to reduced audit quality. Our findings of significantly higher NAS fees and total fees in fraud firms hold after controlling for latent size effects and other rigorous testing. These results contribute to the literature that examines the SEC's concerns regarding NAS and can be used by policy makers for additional consideration.

Does FIN 48 Improve Firms' Estimates of Tax Reserves?

“…While some studies have found a positive association between nonaudit services and low-quality financial reporting (e.g. Frankel, Johnson, and Nelson 2002;Ferguson, Seow, and Young 2004;Srinidhi and Gul 2007;and Markelevich and Rosner 2013) Koh, Rajgopal, and Srinivasan (2013).…”

“… While some studies have found a positive association between nonaudit services and low‐quality financial reporting (e.g. Frankel, Johnson, and Nelson ; Ferguson, Seow, and Young ; Srinidhi and Gul ; and Markelevich and Rosner ), most studies have failed to find an association. See, for example, DeFond, Raghunandan, and Subramanyam (); Ashbaugh, LaFond, and Mayhew (); Chung and Kallapur (); Geiger and Rama (); Kinney, Palmrose, and Scholz (); Reynolds, Deis and Francis (); Antle, Gordon, Narayanamoorthy, and Zhou (); Ruddock, Taylor, and Taylor (); Huang, Mishra, and Raghunandan (); Callaghan, Parkash, and Singhal (); Hope and Langli (); Knechel and Sharma (); Prawitt, Sharp, and Wood (); and Koh, Rajgopal, and Srinivasan (). …”

Non‐audit Services and Auditor Independence Depending on Client Performance

“…That is, companies that were subject to disciplinary actions imposed as the result of an inspection by the Securities and Futures Commission are considered to have proven use of earnings management. Markelevich and Rosner () found a significantly positive relationship between auditor fee variables and SEC‐sanctioned fraud firms.…”

“…6 That is, companies that were subject to disciplinary actions imposed as the result of an inspection by the Securities and Futures Commission are considered to have proven use of earnings management. Markelevich and Rosner (2013) found a significantly positive relationship between auditor fee variables and SEC-sanctioned fraud firms. Thus, this study identified the companies that had disciplinary actions imposed for accounting fraud as the result of an inspection by the Securities and Futures Commission.…”

Research Topics in Accounting Fraud in the 21st Century: A State of the Art

“…Markelevich and Rosner, 2013 [119] The relationship between the different types of auditor fees (total, audit and other services) and fraudulent financial information is considered. Companies that pay high total fees and other services to auditors are more likely to be penalized for fraudulent financial statements.…”