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ABSTRACT
This study investigates whether and how audit quality is associated with the provision of non-audit services by the statutory auditor. Using a sample of 1,008 firm observations of major German listed companies for the sample period 2004-2011, our study is one of the first to thoroughly analyze this issue empirically for the German audit market. Consistent with prior studies we choose discretionary working capital accruals as our proxy for audit quality. Our empirical results demonstrate that total non-audit fees in general and audit related fees in particular are negatively associated with audit quality, while provided tax and other advisory services have an insignificant impact on audit quality. Our results imply that non-audit fees are a significant factor with regard to auditor independence and economic auditor-client bonding while we are not able to detect compensating high knowledge spillover effects from these services. The empirical results are robust to alternative accrual measures and estimation model specifications, while our empirical evidence is not robust with regard to alternative fee measures.
Keywords: Non-Audit Services; Audit Quality; Auditor Independence; Knowledge Spillovers
1 INTRODUCTION
This paper provides empirical evidence on the relation between non-audit services and earnings management, hence audit quality. Our research is motivated by several factors. First, the implication of simultaneously provided audit and non-audit services by auditors has been discussed by regulators and commentators for decades. In general, the joint offering of the two services can be viewed as either a potential benefit resulting in considerable knowledge spillover effects or a potential threat to auditor independence. On October 13, 2010 the European Commission considered the debate in the published Green Paper "Audit Policy: Lessons from the Crisis" (European Commission, 2010). The purpose of this regulatory proposal is to provide improvements with regard to statutory audits in the European Union. As one of its key elements with respect to auditor independence, the regulators in the European Commission proposed that audit firms should not be allowed to provide joined audit and non-audit services to their clients. Moreover, large audit firms should be obliged to separate audit activities from non-audit operations. As the proposed requirements are also considered in the final proposal for the European Parliament and the European Council (European Commission, 201 1), the approved requirements could affect...