This study examines the association between audit and nonaudit service (NAS) fees received by an auditor and the auditor's decision regarding the type of opinion to render to a financially stressed company. Motivation for this study comes from the interest of legislators and regulators about the impact of auditors' fees on audit judgments (SEC 2000a; U.S. GAO 2002; U.S. House of Representatives 2002), the continued interest regarding the importance and frequency of auditors issuing going-concern modified (GCM) opinions to stressed companies (U.S. House of Representatives 1985, 1990; Weil 2001; Dietz 2002; NASDAQ 2002), and the recent actions of the U.S. Congress and the Securities and Exchange Commission (SEC) to prohibit auditors from supplying certain types of nonaudit services to their audit clients and to require publicly traded companies in the U.S. to disclose the type and amounts of fees paid to the external auditor (Sarbanes-Oxley Act 2002; SEC 2000b). In this study, we examine audit reports for a sample of manufacturing companies in financial stress that filed their proxy statements after February 5, 2001, and test for the association between the type of audit opinion issued (going-concerned modified or not) and the level of audit and NAS fees.
The auditing profession has come under increased scrutiny over the past several years about the growing amount of nonaudit fees received from audit clients and the possible negative impact of such fees on auditor independence (Levitt 2000). The SEC and legislators (SEC 2000a, 2000b; U.S. House of Representatives 2002; U.S. Senate 2002) have asserted that significant nonaudit service fees can adversely impact auditor independence and impair auditor decision making, especially when those decisions involve a substantial amount of professional judgment. Such concerns over auditor independence and the level of NAS performed for audit clients led to the SEC's recent enactment of new rules related to nonaudit services supplied by auditors for SEC registrants. The new rules restrict certain types of nonaudit services and also include a fee disclosure requirement (SEC 2000b). Beginning February 5, 2001, SEC registrants must disclose the magnitude of audit fees, financial information systems fees, and all other NAS fees.
Subsequent to the Enron failure, legislative concerns related to nonaudit services led to the recently enacted Sarbanes-Oxley Act (2002). This Act seeks to prohibit certain types of nonaudit services, and also requires that a company's audit committee explicitly approve any other nonaudit service purchase from the incumbent auditor.
This study empirically examines assertions that auditors may act more favorably toward those clients from whom they receive higher NAS fees. We examine the audit reports rendered to financially stressed manufacturing companies and the relative magnitude of nonaudit fees paid by such companies to their auditors. If nonaudit fees can be argued to have an impact on audit judgments, then it is also plausible that the magnitude of audit fees could influence auditor judgments. Hence, we also examine if there is an association between the magnitude of audit fees and audit opinions.
Our analyses of stressed companies find no significant association between receiving a going-concern modified (GCM) audit report and the magnitude of NAS fees. However, we do find a positive association between audit fees and GCM opinions. While the small sample size in our study may limit the statistical power of our tests, our results are extremely robust across numerous alternative models and variable and sample specifications. In addition, as part of our "Further Analyses," we control for the possible endogeneity of audit opinions with audit fees and NAS fees and obtain the same results. The consistent findings obtained from numerous additional analyses give further credibility to our results.
Our findings are also consistent with contemporary research on NAS fees in the U. …