Corporate Governance and Financial Reporting Research

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Corporate Governance and Financial Reporting Research Discussion of “Do nonaudit services compromise auditor independence? Further evidence” by Ashbaugh et al. (2003) TAR

Purpose of the Paper To challenge the findings of Frankel et al. (2002): 1. Frankel et al. (2002) found significant association between nonaudit fees and earnings management; (supports the banning of nonaudit services) 2. Ashbaugh et al. (2003) indicated Frankel et al. (2002) failed to adjust for industry-specific firm performance when measuring earnings management. (not supports the banning of nonaudit services)

Motivation & Contribution I. Motivation: Should SOX prohibit all nonaudit services? Do nonaudit services impair auditor independence? Evidence is presented and is cited in Congressional Hearings. II. Contribution: several important research shows auditor independence is not driven by nonaudit services. As a result, SOX does not prohibit all nonaudit services.

Sample Data and Method I. Sample Data: 3,170 non-financial firms with data in 2000. II. Replicate all results of FJN (2002) and add performance adjustment. II. Regression models are used: Discretionary Accruals (M6/T4, T5) Earnings Surprise (M8/T7) Earnings Increase (M8/T8)

Results/Conclusion Discretionary Accruals: |DCA_PA|= controls + Nonaudit Fees (M6/T4) FEERATIO: p=0.02 / p=0.02 LnNonAF: p=0.01 / p=0.34 Higher NAF, higher absolute DCA which may increase or decrease net income. --- partially consistent with FJN (2002)

Results/Conclusion +DCA_PA= controls + Nonaudit Fees (M6/T5A) FEERATIO: p=0.96 / p=0.48 LnNonAF: p=0.11 / p=0.46 NAF has no influence on positive DCA. -DCA_PA= controls + Nonaudit Fees (M6/T5B) FEERATIO: -0.497, p=0.00 / -0.339, p=0.04 LnNonAF: -0.018, p=0.08 / p=0.82 Higher NAF, higher negative DCA (lower positive DCA) --- lower net income.

Results/Conclusion Earnings Surprise = controls + Nonaudit Fees (M8/T7) FEERATIO: p=0.24 / p=0.25 LnNonAF: p=0.98 / p=0.73 NAF has no influence on EPS surprise (meet or beat forecase EPS). Earnings Increase = controls + Nonaudit Fees (M8/T8) FEERATIO: p=0.66 / p=0.90 LnNonAF: p=0.27 / p=0.41 NAF has no influence on small EPS increase.

Extension I. Components of NAS on earnings quality; II. Partner-Level research; III. Auditor Gender matters? IV. International / Local applications.