Evidence on the Joint Determination of Audit and Non‐Audit Fees

TLDR

Fees are treated as proxies for service level and reflect the physical flow of knowledge, as in prior studies. The study investigates whether client, auditor, and auditor‑client relationship characteristics jointly determine audit and non‑audit fees, and whether previously documented associations are biased by using endogenous variables in single‑equation models. The authors estimate single‑equation models of audit and non‑audit fees to examine their relationship. The analysis shows that audit and non‑audit fees are simultaneously determined, that simultaneous‑equation specifications reveal no association between them, and that the evidence does not support economies of scope or knowledge spillovers between audit and non‑audit services.

Abstract

Abstract In this study we investigate whether the characteristics of clients, auditors, and the auditor‐client relationship simultaneously determine audit and non‐audit fees. As done in prior studies, we maintain that fees proxy for the level of service provided and follow the physical flow of knowledge. Estimating single‐equation models of audit and non‐audit fee models, we confirm prior findings of an association between audit and non‐audit fees. Studies conclude that such evidence is consistent with knowledge spillovers between the two services. However, we document empirically that audit and non‐audit fees are simultaneously determined. Because the data indicate audit and non‐audit fees are jointly determined, we then investigate whether previously documented associations between audit and non‐audit fees are the result of biased estimation induced by using endogenous variables in single‐equation models. In contrast to results from single‐equation estimations, we find no association between audit and non‐audit fees using a simultaneous specification of the fee system, suggesting that single‐equation estimations suffer from simultaneous‐equations bias. In sum, the findings are not consistent with the existence of economies of scope from the joint performance of audit and non‐audit services after controlling for the joint behavior of audit and non‐audit fees. Given the ongoing debate over the level of allowed non‐audit services by auditors, the argument for the joint provision of audit and non‐audit services is less justified than if joint‐supply benefits had been documented.