Perceived auditor independence and audit firm fees

Abstract

Regulations requiring the disclosure of fees paid to an auditor for audit and non-audit services (NAS) respond to concerns that such payments are potentially detrimental to auditors’ actual or perceived independence. Although empirical studies have failed to produce unequivocal evidence of detrimental effects on auditor independence, the actions of regulators, auditor firms and auditees is consistent with the belief that economic bonding generated by fees can impair perceived levels of auditor independence.

This paper studies perceived impairment of auditor independence by examining the relationship between levels of total relative auditor fees (audit and NAS fees combined) and auditees’ market value for a sample of UK firms over a six year period. The paper’s methodological innovation is its use of a valuation framework in this setting. A further contribution lies in dropping the assumption of linearity found in most prior empirical studies. We provide evidence that shareholders perceive a threat to auditor independence only at high total relative fee levels. At lower levels, total fees are positively related to firm value. These results suggest that disclosure of NAS and audit fees are of relevance to investors, as is information about auditor income. Our results support the view that regulation by reference to threshold total relative fees is more consistent with investor preferences than prohibition of the supply of NAS by auditors to auditees.

Key words: auditor independence, audit fees, non-audit services, firm valuation

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