Academic journal article Auditing: A Journal of Practice & Theory

Nonaudit Services and Shareholder Ratification of Auditors

Academic journal article Auditing: A Journal of Practice & Theory

Nonaudit Services and Shareholder Ratification of Auditors

Article excerpt


The Securities and Exchange Commission (SEC 2000b) recently issued new rules related to nonaudit services (NAS). The rules adopt a two-pronged approach by prohibiting auditors from rendering certain types of nonaudit services to their audit clients and requiring registrants to disclose data about audit and nonaudit fees.

The SEC (2000a) argued that the fee disclosures would be useful to investors by giving "insight into the full relationship between a company and its auditor" and to "replace uncertainty about the nature and scope of such relationships with facts about the services provided by the auditor to the company." The SEC suggested that information about the fees paid to the auditor "may help shareholders decide, among other things, how to vote their proxies in selecting or ratifying management's selection of an auditor." Along these lines, some investors also suggested, in their comment letters to the SEC and during the subsequent hearings, that they would find the disclosures useful. For instance, a representative of the largest institutional fund (TIAA-CREF) noted that:

   As a shareholder, we frequently are asked to vote to approve the
   auditors of our portfolio companies. Information on provision of
   nonaudit services, were such information available,
   would be important in informing our vote. This is a reason why such
   disclosure should be made in the proxy statement, rather than the
   10-K or other documents, which are not always available
   when we cast our votes. (Clapman 2000)

In light of such assertions, this paper examines if there are cross-sectional differences in shareholder votes related to the ratification of the external auditor (selected by management) based on the relative magnitude of nonaudit fees. I also examine whether voting proportions related to auditor ratification have changed after the disclosure requirements, by comparing the proportions before and after the new disclosure rules became effective. Finally, the descriptive evidence about the proportion of shareholders who decline to ratify the auditor is also useful in the debate about the impact of nonaudit services on investors' perceptions of auditor independence.


Corporate Governance and Shareholder Voting

Since Berle and Means (1932), a large body of research has examined diverse forms of agency conflicts arising from the divergent interests of a firm's managers and its owners (more broadly, suppliers of capital). The classical solution to this problem of governance in joint stock companies has been for the owners to appoint a board to oversee management and to engage an independent auditor to provide assurance about management's financial reports to shareholders. Owners retain overall control through their right to vote on important governance proposals. Subjecting important managerial decisions to stockholder review essentially acts as a check on managerial opportunism.

Proposals presented for shareholder approval may be initiated by managers or by stockholders. (1) Under some stock-exchange guidelines, management-initiated proposals can be further classified as routine or nonroutine. (2) Instances of routine matters include uncontested elections of directors, votes to ratify the appointment of auditors, and authorizations to issue stock or stock options to directors, officers, and employees in amounts less than 5 percent of the total amount outstanding. In this framework, the shareholder voting on the appointment of independent auditors that I examine in this study would be classified as voting on a routine management-initiated proposal.

While there is a large literature on shareholder-initiated voting, empirical research related to routine management-initiated proposals is more limited. (3) Some papers have recently examined shareholder voting related to management-initiated stock option issuance proposals (Thomas and Martin 2000; Johnson et al. …

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