Audit and Nonaudit Fees and the Market's Reaction to Earnings Announcements

Effective February 05, 2001, publicly traded companies are required to disclose audit and nonaudit fees paid to their external auditors. These fee data have been used to test whether auditor independence is impaired when the external auditor provides nonaudit services to a client, usually by examining whether certain earnings characteristics are related to nonaudit fees in ways that suggest impairment. This paper follows in that tradition by testing whether the earnings response coefficient (ERC), a proxy for earnings quality, is associated with engagement profitability. Residual fees derived from a two‐stage regression model that prices audit and nonaudit services simultaneously are used to proxy for engagement profitability. If the market perceives abnormally profitable engagements as a threat to auditor independence, then we would expect the ERC to be lower for firms with positive fee residuals. The paper examines the residual fee‐ERC relation for annual earnings announcements immediately before and af...

[1]  Lynn Rees,et al.  The Effect of Beating and Missing Analysts' Forecasts on the Information Content of Unexpected Earnings , 2002 .

[2]  R. Freeman,et al.  A NONLINEAR MODEL OF SECURITY PRICE RESPONSES TO UNEXPECTED EARNINGS , 1992 .

[3]  Sudipta Basu.  The conservatism principle and the asymmetric timeliness of earnings , 1997 .

[4]  William R. Kinney,et al.  Auditor Independence, Non‐Audit Services, and Restatements: Was the U.S. Government Right? , 2004 .

[5]  C. Dee,et al.  Earnings Quality and Auditor Independence: An Examination Using Non-audit Fee Data , 2002 .

[6]  M. Zmijewski.  METHODOLOGICAL ISSUES RELATED TO THE ESTIMATION OF FINANCIAL DISTRESS PREDICTION MODELS , 1984 .

[7]  R. Lipe,et al.  Do nonlinearity, firm-specific coefficients, and losses represent distinct factors in the relation between stock returns and accounting earnings? , 1998 .

[8]  Srinivasan Sankaraguruswamy,et al.  Evidence on the Joint Determination of Audit and Non-Audit Fees , 2003 .

[9]  Roger C. Kormendi,et al.  Earnings Innovations, Earnings Persistence, and Stock Returns , 1987 .

[10]  K. Subramanyam,et al.  Going‐Concern Status, Earnings Persistence, and Informativeness of Earnings* , 1996 .

[11]  Sanjay Kallapur,et al.  Client Importance, Nonaudit Services, and Abnormal Accruals , 2003 .

[12]  Ryan LaFond,et al.  Do Nonaudit Services Compromise Auditor Independence? Further Evidence , 2003 .

[13]  Terry D. Warfield,et al.  Managerial ownership, accounting choices, and informativeness of earnings , 1995 .

[14]  Neil Fargher,et al.  The association between unexpected earnings and abnormal security returns in the presence of financial leverage , 1991 .

[15]  Mark L. DeFond,et al.  The Effect of Audit Quality on Earnings Management , 1998 .

[16]  R. Freeman,et al.  The association between accounting earnings and security returns for large and small firms , 1987 .

[17]  Robert E. Verrecchia,et al.  THE EFFECT OF SEQUENTIAL INFORMATION RELEASES ON THE VARIANCE OF PRICE CHANGES IN AN INTERTEMPORAL MULTI-ASSET MARKET , 1988 .

[18]  E. Fama,et al.  Multifactor Explanations of Asset Pricing Anomalies , 1996 .

[19]  Marilyn F. Johnson,et al.  The Relation between Auditors' Fees for Nonaudit Services and Earnings Management , 2002 .

[20]  Dana R. Hermanson,et al.  Board Characteristics and Audit Fees , 2000 .

[21]  Carla K. Hayn.  The information content of losses , 1995 .

[22]  Charles E. Wasley,et al.  Estimating earnings response coefficients: Pooled versus firm-specific models , 1996 .

[23]  Mark L. DeFond,et al.  Do Non-audit Service Fees Impair Auditor Independence? Evidence from Going-concern Audit Opinions , 2002 .

[24]  S. Kothari,et al.  An analysis of intertemporal and cross-sectional determinants of earnings response coefficients , 1989 .

[25]  J. Maher,et al.  Nonaudit Fees, Auditor Independence, and Bond Ratings , 2004 .

[26]  David F. Larcker,et al.  Fees Paid to Audit Firms, Accrual Choices, and Corporate Governance , 2004 .

[27]  Alan Gregory,et al.  Audit committee effectiveness and the audit fee , 1996 .

[28]  Edward I. Altman,et al.  FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY , 1968 .

[29]  Debra C. Jeter,et al.  The effects of qualified audit opinions on earnings response coefficients , 1992 .