How Do Audit Firms Respond to Fee Pressure? Evidence of Increased Nonaudit Services and Their Impact on Audit Quality

• In Event: Client Importance and Nonaudit Fees

Abstract

Recent academic research has noted a substantial decline in audit fees beginning in the mid-2000’s, largely due to the worldwide recession (Christensen et al. 2014b; Ettredge et al. 2014). We investigate whether audit firms respond to audit fee pressure by increasing the extent to which they provide nonaudit services as a way to compensate for reduced audit revenues. Using audit offices as our unit of observation, we find a significant, positive relation between audit fee pressure and changes in nonaudit services. This relation is predominantly evident among small and mid-sized offices. Further, we find that audit fee pressure is positively related to the rate of client misstatements. Importantly, we find that audit fee pressure is associated with rate of client misstatement only when firms increase nonaudit services, and increases in nonaudit services are associated with rate of client misstatement only in the presence of audit fee pressure. Finally, we provide evidence of a nonlinear relation between the extent of nonaudit services and rate of misstatement. Overall, our study provides evidence that audit offices’ nonaudit services are another important dimension to include when considering the effects of declining audit fees on the audit profession.

Authors

• Erik Beardsley, Texas A&M University

• Dennis R. Lassila, Texas A&M University

• Thomas C. Omer, University of Nebraska–Lincoln