The Relation Between Auditors' Fees for Non-Audit Services and Earnings Management

TLDR

The study investigates the relationship between auditor fees and earnings management, as well as market reactions to fee disclosures. The authors analyze proxy statement data to show that non‑audit fees correlate positively with earnings surprises and discretionary accruals. Non‑audit fees are linked to higher earnings‑management indicators, audit fees to lower indicators, and the former are associated with a modest negative impact on share prices upon disclosure, with all results robust across specifications.

Abstract

This paper examines whether auditor fees are associated with earnings management and the market reaction to the disclosure of auditor fees. Using data collected from proxy statements, we present evidence that non-audit fees are positively associated with small positive earnings surprises, the magnitude of absolute discretionary accruals, and the magnitude of income-increasing and income-decreasing discretionary accruals. In contrast, audit fees are negatively associated with these earnings management indicators. These results are robust to a variety of alternative variable definitions and model specifications. Specifically, contrary to the claims of Ashbaugh et al. (2002), the results are robust to the use of performance-matched discretionary accruals. Moreover, contrary to the claims of Francis and Ke (2002), the results for small positive earnings surprises are robust regardless of whether the comparison group is all other earnings surprises or small negative earnings surprises. Our final set of results provide evidence of a significant negative association between non-audit fees and share values on the date the fees were disclosed, although the effect is small in economic terms.