The IUP Journal of Audit Practice

Discretionary Accruals, Managerial Incentives, and Audit and Non-audit Service Fees: Joint Determination Effects

-- J-L W Mitchell Van der Zahn and Greg Tower

This study examines the linkages between discretionary accruals, management ownership and remuneration and non-audit service fees. All findings of the study are based on an extensive analysis of 351 publicly listed firms of Singapore for the fiscal year 2001. Inferential statistics results, using Ordinary Least Squares (OLS) and Two-Stage Least Square (2SLS), reveal three key findings. First, there is a negative association between discretionary accruals and non-audit service fees. Second, managerial ownership positively affects the negative association between discretionary accruals and non-audit service fees. Third, this positive affect is weaker amongst firms with high accounting-based management remuneration. It is also documented that when single-equation estimates are used, audit committee effectiveness has a significant positive (negative) influence on audit coverage (purchase non-audit service fees). Even after fee endogeneity is controlled, the evidence shows that audit committee effectiveness is not associated with the purchase of either audit or non-audit service fees. Findings from single-equation models of audit and non-audit service fees confirm prior research showing a knowledge spillover effect. Consistent with emerging literature, it has been observed that when simultaneous-equations are used, the association between audit and non-audit service fees suffers from simultaneous-equation bias. Thus, consistent with Whisenant et al., (2003) the authors conclude that there is no knowledge spillover between the audit and non-audit service fees. Another key feature of this article is the expansion of very limited literature, investigating linkages between audit committee effectiveness and the audit and non-audit service fees. Finally, the authors infer that failure to control feedback relationship between the audit and non-audit service fees would probably produce spurious findings and inferences.

© 2006 IUP . All Rights Reserved.

The Effect of the Enron-Andersen Affair on Audit Pricing

-- Wuchun Chi

This article examines whether and how the Enron-Andersen affair changed audit fees. This is accomplished by investigating a sample before (years 2000 and 2001) and after (years 2002 and 2003), the occurrence of this prominent event in the US audit market. The results show that on an average, audit fees are higher after the Enron-Andersen affair but the increased audit fees originate from the remaining Big 4 audit firms instead of the non-Big 4 audit firms. The fee-cutting phenomenon in an initial engagement is still applicable to former Andersen clients, who had changed to a new auditor in the year 2002. However, among the clients of Big 4 firm auditors, the degree of fee-cutting is statistically greater for former Andersen's clients as compared to non-former Andersen's clients, ceteris paribus. The changed structure of audit pricing is not just a reaction by the audit industry after the first year of the affair, but has lasted to the second year. Finally, post-Enron, the author finds evidence of higher fees for Big 4 industry specialists relative to non-specialist auditors, but this result only applies when the client is a small company.

© 2006 IUP . All Rights Reserved. An earlier version of this working paper was presented in the Western Region AAA Annual Meeting, April 28-30, Sacramento, California.

Audit Quality, Materiality and Threshold-induced Earnings Management

-- Van Caneghem Tom

Several studies (see e.g. Burgstahler & Dichev, 1997; Degeorge, Patel & Zeckhauser, 1999; Gore, Pope & Singh, 2001; Holland & Ramsay, 2003) document statistically significant discontinuities in the distribution of reported earnings figures around certain targets (i.e., zero earnings, s' earnings forecasts and prior year's earnings). These discontinuities are ascribed to threshold-induced earnings management. Relying on a sample of listed UK firms and employing a similar methodology, the author examines whether high-quality audits serve as a constraint on earnings management practices.The author relies on the traditional brand name proxy (i.e., BigN vs. non-BigN auditors) and a proxy for auditors' industry expertise to capture audit quality. While results suggest that high-quality audits constrain loss avoidance, this is not true for earnings management aimed at meeting last year's earnings figure. This discrepancy of results is attributed to the fact that the latter type of earnings enhancement will often not be quantitatively material and the auditors (i.e., both high- and low-quality auditors) neglect qualitative factors to assess materiality.

© 2006 IUP . All Rights Reserved.

Mandatory Auditor Rotation and Retention: Impact on Market Share

-- Christie L Comunale and Thomas R Sexton

The article explores the effects of mandatory auditor rotation and retention on the long-term market shares of the accounting firms that audit the members of the Standard and Poor's (S&P) 500. A Markov model is constructed that depicts the movements of S&P 500 firms in the period 1995 to 1999 among Big 5 accounting firms. Auditor rotation and retention are reflected in the transition probabilities. The impacts of mandatory auditor rotation and retention policies are evaluated by examining the state probabilities after two, five, and nine years. The paper finds that mandatory auditor rotation will have substantial effects on long-term market shares, whereas mandatory auditor retention will have very small effects. It shows that a firm's ability to attract new clients, as opposed to retaining current clients, will be the primary factor in determining the firm's long-term market share under mandatory auditor rotation. The paper opines that S&P 500 firms will continue their reliance on Big 5 firms and that the estimated transition probabilities will remain stable over time. Excessive market share concentration resulting from such policies should not be a concern of regulators. The paper conjectures that under mandatory rotation, accounting firms will reallocate resources to attract new clients rather than retain existing clients. This may result in lower audit quality. Interestingly, over the past 25 years, several bodies have considered mandatory auditor rotation and retention. Surprisingly, the authors have found no studies of the effects of mandatory auditor rotation and retention on audit market share.

© 2005 Emerald Group Publishing Limited. This article was earlier appeared in Managerial Auditing Journal, Vol. 20, No. 3, 2005, pp. 235-248. Reprinted with permission.