Impact of non-audit services and tenure regulations on auditor independence and financial reporting quality : evidence from the UK

• Main Author: Islam, Md Shahidul
• Published: Cardiff University 2016
• Subjects: 657; HG Finance
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.685518

In response to the spectacular financial reporting failures in Western economies in the early 21st century, the UK has undergone a series of regulatory reforms and the Ethical Standards (ES) by the Auditing Practices Board (APB) are among the most prominent. While the issues of joint provision of audit and non-audit services (NAS) and long audit firm tenure died down following the enactment of ES in 2004, they attracted comments from regulators and policymakers in the wake of the 2007-09 financial crisis. This makes such joint provision and extended tenure long-standing, potentially unresolved issues even in a changed regulatory setting. In this context, the current study has been motivated to investigate the impact of NAS and audit firm tenure regulations on de facto auditor independence and financial reporting quality (FRQ) of FTSE350 companies. Using estimates of discretionary accruals and measures for auditors‟ economic dependence, the study finds little support against popular arguments that NAS fees and long audit firm tenure erode FRQ. Out of two measures of auditors‟ economic dependence, „total fees to auditors‟ is documented to be significantly negatively associated with discretionary accruals during the post-APB ES period. The „differencein- differences‟ method provides some evidence at a marginally significant level for ES‟s causal impact in improving FRQ during post-APB ES period, ceteris paribus. Tests of association between audit firm tenure and FRQ suggest, with a caveat of marginally significant results, that audits conducted during the post-APB ES period have a mitigating effect on discretionary accruals and that longer audit firm tenure does not compromise auditor independence but in fact helps to improve FRQ in the form of lower discretionary accruals. These empirical findings have weak support for policymakers‟ views that an outright prohibition on supplying NAS for audit clients and mandating more frequent rotation of auditors would help to improve FRQ. Results from the final set of tests suggest a marginally significant negative association between audit firm tenure and discretionary accruals for companies audited by Big4 auditors but not for those audited by their non-Big4 counterparts. This provides insight to the most recent regulatory concerns about the concentrated audit market with Big4 domination. The study, therefore, makes important empirical contributions with policy implications.