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Review of Quantitative Finance and Accounting

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01.01.2009 | Original Research

Non-audit service and auditor independence: an examination of the Procomp effect

verfasst von: Rong-Ruey Duh, Wen-Chih Lee, Chi-Yun Hua

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 1/2009

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Abstract

This paper examines whether non-audit service provision impairs auditor independence, and whether the degree of auditor independence in Taiwan changed in the wake of the 2004 Procomp scandal. The auditors involved in the Procomp affair were suspended from practice for 2 years and were sued, and we posit that these unprecedented sanctions and litigation affected subsequent auditor behavior. Considering the measurement errors involved in discretionary accruals, we propose an alternative analytic approach in which the dependent variable in the regression analysis is the difference between audited earnings and forecast earnings, scaled by total assets, and the primary independent variable is the non-audit fees ratio. After controlling for the effects of financial leverage, operating and market performance, industry, company size, audit firm size, management forecast error, and management attempts to manipulate earnings, regression analysis indicates that the coefficient for non-audit fees ratio is negative and significant in 2003 but not in 2004. Using non-audit fees instead of non-audit fees ratio to conduct the regression analysis yields similar results. This finding is consistent with the notion that auditors make a trade-off between gaining service fees and avoiding litigation and reputation loss. Limitations and policy implications are also offered.

Vorheriger Artikel Is there a viable alternative to ordinary least squares regression when security abnormal returns are the dependent variable?

Nächster Artikel The influence of managerial incentives on the resolution of financial distress

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See the Appendix for a description of the Procomp scandal.

In an institutional situation unique to Taiwan, listed companies that have announced earnings forecast during a given year are required to announce their un-audited annual earnings by the end of January of the following year. Listed companies are required to announce their audited annual earnings by the end of April regardless of whether or not they have issued an earnings forecast.

Shortly after the Procomp scandal emerged in June 2004, the FSC suspended the company’s auditors from practice for 2 years, and the Investor Protection Center filed a class action civil suit against those auditors. The Procomp scandal is not associated with provision of non-audit services to the audit client per se, but the severe and fast sanctions and legal action against auditors had never occurred in Taiwan before.

According to SAS No. 39, Type I and Type II errors are the two types of decision errors that an auditor can make when deciding that sample evidence supports or does not support a test of controls or a substantive test based on a sampling procedure. These errors are sometimes referred to as alpha and beta risks. In relation to tests of controls, a type I error occurs when the assessed level of control risk based on the sample is greater than the true risk given the effectiveness of the control in practice, and a type II error occurs when the assessed level of control risk based on the sample is less than the true risk given the effectiveness of the control. In relation to substantive tests, a type I error is made when the sample supports the conclusion that the recorded account balance is materially misstated when it is not materially misstated, and a type II error is made when the sample supports the conclusion that the recorded account balance is not materially misstated when it is materially misstated. We applied the above concept in our study.

The NT dollar to US dollar conversion rate used is 32.69:1. In the following, we use this conversion rate to express figures in US dollars.

Although audit fees and non-audit fees are disclosed to the public, the public may not be able to discern the difference in these fees among companies. We thus use the mean of the fees (ratio) to split the sample. Companies with fees (ratio) higher than the mean are assigned 1; 0 otherwise. In the following, we use the dichotomized fee (ratio) for analysis. We also conduct a robustness check using continuous data (i.e., without dichotomization) in a subsequent section.

According to regulations in Taiwan, within 4 months following the close of each fiscal year, a listed company should disclose to the public its audited financial reports, and within 1 month after the end of the first (and third) quarter of each fiscal year, it should disclose to the public its reviewed financial reports.

The NT dollar to US dollar conversion rate used here is 32.69:1. In the following, we express amounts in US dollars.

In Taiwan, two engagement partners must sign off on the audit report for an engagement.

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Titel: Non-audit service and auditor independence: an examination of the Procomp effect
verfasst von: Rong-Ruey Duh
Wen-Chih Lee
Chi-Yun Hua
Publikationsdatum: 01.01.2009
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 1/2009
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-007-0080-5

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