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Non-Audit services, auditor independence and earnings management

Research output: Working paper

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Abstract

We predict that the provision of non-audit services by auditors to their audit clients will impair independence more severely for smaller auditors than for large auditors. We report evidence that client earnings management activity to avoid losses and earnings decreases is positively associated with the ratio of non-audit fees to total fees for non-Big 5 auditors but not for Big 5 auditors. Earnings management to meet analysts' forecasts varies positively with the non-audit fee ratio for both Big 5 and non-Big 5 auditors. Further, the difference in the effectiveness of Big 5 and non-Big 5 auditors in constraining earnings management widens as the non-audit free ratio increases. These results suggest that, when the provision of non-audit services is relatively high, smaller auditors are less able to resist aggressive accounting by their clients.