DOI 10.1007/s11301-009-0043-0 STATE-OF-THE-ART-ARTIKEL Review of empirical research on rotation and non-audit services: auditor independence in fact vs. appearance Christiane Pott · Theodore J. Mock · Christoph Watrin Received: 14 May 2008 / Accepted: 16 December 2008 / Published online: 29 January 2009 © Wirtschaftsuniversit ¨ at Wien, Austria 2009 Abstract Confidence in the processes of corporate reporting and auditing has rapidly decreased recently due to front-page accounting scandals in both the United States and Europe. The goal of audit regulations, such as the Sarbanes Oxley Act in the United States (US) and the 8th Directive in the European Union (EU), is to restore public trust in the auditing process. Along with other regulatory aspects, requirements related to audit partner rotation and bans on providing concurrent non-audit services were implemented to maintain auditor independence, both in fact and in appearance. However, the implementation of audit regulation implies that increased requirements are able to enhance the failed audit function. Empirical research should help to un- derstand the impact of these two regulatory aspects and indicate their effectiveness in maintaining auditor independence. Thus, we outline the newest empirical research re- lated to audit partner rotation and non-audit services and independence in fact or in appearance. Overall, we conclude that prior research does not point to one particu- lar requirement that would most effectively restore trust in the audit function. Rather the existence of multiple threats to auditor independence might demand a combina- tion of several requirements to maintain auditor independence. Thus, more research C. Pott (✉) Institut f ¨ ur Unternehmensrechnung und -besteuerung, Westf ¨ alische Wilhelms-Universit ¨ at M ¨ unster, Universit ¨ atsstr. 14–16, 48143 M ¨ unster, Germany e-mail: christiane.pott@wiwi.uni-muenster.de T. Mock Anderson Graduate School of Management, University of California, 900 University Avenue, Riverside, California 92521, USA e-mail: ted.mock@ucr.edu C. Watrin Institut f ¨ ur Unternehmensrechnung und -besteuerung, Westf ¨ alische Wilhelms-Universit ¨ at M ¨ unster, Universit ¨ atsstr. 14–16, 48143 M ¨ unster, Germany e-mail: christoph.watrin@wiwi.uni-muenster.de 13 J Betriebswirtsch (2009) 58: 209–239 210 C. Pott et al. is needed to investigate the joint effects of different threats to auditor independence, e. g., non-audit fees and audit partner tenure. Keywords Auditor independence · European Union · Regulation Zusammenfassung Durch Bilanzskandale in den USA und Europa wurde das Vertrauen in die Unternehmens-berichterstattung und die Abschlusspr ¨ ufung stark ersch ¨ uttert. Das Ziel von Gesetzesinitiativen wie der Sarbanes-Oxley Act in den USA und der 8. EU-Richtlinie ist daher die Wiederherstellung des Vertrauens in die Abschlusspr ¨ uferfunktion. Neben anderen regulatorischen Maßnahmen betreffen die gesetzliche ¨ Anderungen die Rotation des verantwortlichen Pr ¨ ufungspartners und das Verbot, bestimmte Nicht-Pr ¨ ufungsleistungen f ¨ ur Pr ¨ ufungsmandanten zu erbringen. Diese Regelungen wurden implementiert, um ,,auditor independence in fact“ und ,,auditor independence in appearance“ zu erhalten. Die Einf ¨ uhrung der gesetzlichen Anforderungen impliziert ex ante, dass die jeweiligen gesetzlichen Bestimmungen in der Lage sind, die deutlich in Kritik geratene Abschlusspr ¨ uferfunktion zu stabi- lisieren. Empirische Forschungsergebnisse k ¨ onnen in diesem Zusammenhang dazu dienen, den Einfluss der drei oben genannten gesetzlichen ¨ Anderungen im Hinblick auf die Erhaltung der Abschlusspr ¨ uferunabh ¨ angigkeit zu beurteilen. Daher stellt die- ser Beitrag die neueste empirische Forschung zur Abschlusspr ¨ uferrotation und zu Nicht-Pr ¨ ufungsleistungen in Bezug auf ,,auditor independence in fact“ und ,,auditor independence in appearance“ vor. Insgesamt lassen die empirischen Befunde keine Aussage dar ¨ uber zu, welcher spezifische Regulierungsaspekt zur Wiederherstellung des Vertrauens in die Abschlusspr ¨ ufung beitr ¨ agt. Vielmehr k ¨ onnte das gleichzeitige Vorliegen verschiedener Bedrohungen f ¨ ur die Abschlusspr ¨ uferunabh ¨ angigkeit eine Kombination verschiedener regulatorischer Maßnahmen erforderlich machen. Um diesen Zusammenhang zu untersuchen, sind jedoch weitere empirische Untersuchun- gen n ¨ otig, die sich gezielt mit der gleichzeitigen Auswirkung der Rotation des verant- wortlichen Pr ¨ ufungspartners und dem Verbot, bestimmte Nicht-Pr ¨ ufungsleistungen zu erbringen, auseinandersetzen. Schl ¨ usselw ¨ orter Wirtschaftspr ¨ uferunabh ¨ angigkeit ·Europ ¨ aische Union · Regulierung JEL Klassifikationen M42 1 Introduction The role, position, and liabilities of the statutory auditor in the European Union are regulated individually by each Member State. However, the increasing number of large-scale financial failures has led to calls for harmonization of the audit function. Increasingly, there is a general belief that the lack of common practices or standards negatively affects audit quality (European Commission 1996). Worldwide account- ing scandals have been followed by harsh criticism of the auditing profession. In 13 Review of empirical research on rotation and non-audit services 211 the United States, the Enron collapse had a major impact on relevant regulations. However, almost every European country also experienced an accounting scandal around 2001. SAirGroup in Switzerland had to acknowledge corporate governance violations in 2001, the Belgian company Lernout & Hauspie was accused of fraud and market price manipulation in 2001, and by 2003, the Netherlands was unset- tled by Ahold’s exaggerated earnings forecasts (Peem ¨ oller and Hofmann 2005). The list of companies facing similar issues is quite long, including Parmalat in Italy in 2003, the Austrian company Yline in 2003, and Philipp Holzmann and Comroad in Germany in 2002. In response, regulating bodies in the United States and the European Union each issued major pieces of legislation: in the United States, the Sarbanes-Oxley Act in 2002, and in the European Union, the revised 8th Direc- tive (2006). These regulations include more severe penalties and larger enforcement budgets to protect financial markets from fraud (see, e. g., Krishnamurthy, Zhou, and Zhou 2006). According to Bolkestein (2003, p. 1), the “Directive aims to reinforce the statu- tory audit function in the Euroepan Union, which is one of the crucial elements for underpinning the trust in the functioning of the European capital market.” The re- vised 8th Directive was intended to become law by mid-2005, but it was not finally issued until the end of June 2006. The Member States had to incorporate the minimal requirements of the Directive into national law by June 2008. Among other things, the 8th Directive (2006) establishes principles concerning auditor independence, yet the requirements of the Directive do not directly address the auditor (at least in this stage of regulation). Moreover, this regulation addresses Member States because they must first incorporate the requirements into their own national law before the rules be- come binding on auditors and other involved parties. Member States often add local requirements to the minimum requirements issued, and thus each State differs in how it establishes its requirements. Here, we build on the existing literature by providing insights into the new and fast-growing research area of the impact of regulation on auditors. Dissociating themselves from the institutional system of self-regulation, auditors are faced with a continuously growing set of additional requirements. For example, auditors are now charged with understanding and applying the relevant local regulations to ensure compliance. The auditor is now required to rotate from his or her audit client to avoid audit bias. Prior literature reviews on auditor independence were done several years ago and, consequently, do not include important empirical findings from the post-SOX period (see, e. g., Ewert 2003). Also, many literature reviews focus on empirical findings re- lated to one independence issue, such as non-audit services (Schneider, Church, and Ely 2006) or audit firm rotation (Cameran, Di Vincenzo, and Merlotti 2005). Prior literature is the only evidence available by which we can study the real effects of regu- lation. Therefore, we present a structured review of the most important empirical and experimental literature on auditor independence. This analysis will lead to an assess- ment of the probable effectiveness of auditor independence regulation. Therefore, we try to answer the following question: Is the regulation of auditor independence ef- fective and necessary? We arrive at the answer through the findings of the existing empirical literature. 13 212 C. Pott et al. Our paper proceeds as follows: Section 2 defines auditor independence in both fact and appearance and explains different theoretical approaches to auditor inde- pendence. The regulation related to auditor independence is presented in Sect. 3. Section 4 presents and discusses prior empirical research on auditor independence. Section 5 concludes with perspectives on future research. 2 Auditor independence The ex ante value of an audit to consumers of audit services (including current and potential owners, managers, shareholders and consumers of the firm’s products) de- pends on the auditor’s perceived ability to: (1) Discover errors or breaches in the accounting system, and (2) withstand client pressure to disclose selectively in the event a breach is discovered. In this context, the level of auditor independence can be defined as the conditional probability that – given that a breach has been discovered – the auditor will report the breach (DeAngelo 1981a, pp. 115–116; 1981b). For the purposes of many regulatory frameworks, independence is separated into two related concepts. First, independence requires independence in mind, defined as a state of mind that (1) is unaffected by influences that might compromise profes- sional judgment, and that (2) allows an individual to act with integrity and to exer- cise objectivity and professional skepticism (International Federation of Accountants 2004, p. 17). 1 Regulatory frameworks also often use the phrase “independence in fact” when referring to independence in mind (Securities and Exchange Commission 2001; European Commission 2002). Second, independence requires independence in appearance, which is described as the avoidance of significant facts and/or circum- stances that would reasonably cause a rational and informed third party to conclude that a firm’s (or a member of the assurance team’s) integrity, objectivity or profes- sional skepticism had been compromised (International Federation of Accountants 2004, p. 17). The appearance of an independence failure is enough to undermine con- fidence in auditing and financial reporting. This is due to the suspicion (belief) that independence is impaired, because independent behavior (independence in fact) is unobservable. The result of evidence (or simple belief) of auditor failure leads to a loss of trust in the audit process and, more generally, in financial reporting, thus destabilizing markets (Fearnley and Beattie 2004, p. 121). Originally deserved trust, defined as the expectation people have of each other (Barber 1983), can also be unsettled by other means. Aside from financial statements and audit reports, users and auditors in today’s world are flooded with information from a number of sources (e. g., business magazines, newspapers, internet, television, etc.). According to extant research, this kind of information influences decision- makers’ perceptions, attitudes, decisions, and behaviors (e. g., Barber and Odean 1 The International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC) serves the public interest by setting – independently and under its own authority – high quality standards dealing with auditing, review, other assurance, quality control and related services, and facilitating the convergence of national and international standards. This enhances the quality and uniformity of practice in these areas throughout the world, as well as strengthened public confidence in financial reporting generally. 13 Review of empirical research on rotation and non-audit services 213 2008). Additionally, this information can influence decision-makers’ ex post evalu- ations of other professionals’ behaviors and responsibilities (e. g., Bonner 2008). In summary, several prior studies have found that users have disproportionate expecta- tions of auditors, whereas the auditor’s performance does not (have to) meet those expectations. Extensive media reporting on audit scandals and inappropriate auditor behavior leads users to experience the gap between their expectations and the ac- tual behavior of the auditor (e. g., Porter 1993), which cannot be directly attributed to a failure of independence either in fact or in appearance. Explanations for the loss of trust in audit quality are largely based on the devel- opment of the auditing sector over the last four decades. Following their geographic expansion and increased competition, audit firms have been driven towards prof- itability and growth to maintain competitiveness. The industry has had to generate more revenue by both securing new audit clients and retaining existing ones. Due to the demand of globally-operating clients, other services became alternative profit generators. Thus, a growing percentage of public accounting firms’ total revenues began to come from non-audit services, such as tax advice, information systems de- sign and implementation, human resource management and general consulting (see, e. g., Palmrose 1986; DeFond, Raghunandan, and Subramanyan 2002). This increase reflects an absolute growth in non-audit activities coupled with stagnation in the audit-service market. However, the joint provision of audit and non-audit services to a client implies the existence of different contractual relationships between the audi- tor and the client (Antle 1982, 1984). Agency theory explains this phenomenon in terms of the separation of ownership by investors and control by management (Jensen and Meckling 1976). The agency re- lationship is specified by the contract under which the owners (principals) engage the management (agent) to manage the firm on their behalf. Since both parties to the re- lationship are utility maximizers, the agent will not always act in the best interest of the principals (Antle 1984, p. 2). This may result in divergent interests and investor losses, due to opportunistic agent behavior. The use of an external auditor is one control mechanism for reducing the risk of managers’ opportunism. However, the external auditor is still hired by the owner as an agent. The auditor-agent must produce information to be used in contracting with the manager (Antle 1984, p. 2). Therefore, the auditor is required to maintain indepen- dence from the client management. In considering the impact of non-audit services on auditor independence, it is important to point out that where audit and non-audit services are provided to the same client, two different contractual relationships exist (Beattie, Fearnley, and Brandt 1999). The non-audit services contractual relationship is with the client. In the auditing contractual relationship, however, the auditor owes an additional duty to the stakeholders. Moreover, the audit is subject to regulatory oversight. However, the audit firm may perceive the purchase of an audit in the same light as that of any other service. The provision of non-audit services to audit clients increases the economic bond between the audit firm and the client. This bond could lead to impaired independence because (1) the audit firm is unwilling to criticize the work done by its non-audit ser- vice department, (2) the audit firm does not want to lose lucrative non-audit services provided to the audit client, and (3) the audit firm does not want to lose the audit en- 13 214 C. Pott et al. gagement. In such a situation, the auditor may be inclined to agree with management interpretations of accounting issues. In this respect moral hazard could lead the audi- tor to agree with a certain level of dependency on the client in response to receiving an additional amount of non-audit service fees. In such a situation moral hazard would be covered legally under the additional non-audit service fees. Thus, the auditor has her or his own opportunistic incentives, which may lead to biased judgments about the nature and scope of the examination (audit work) made and biased reporting as to whether the financial statements fairly represent the financial condition of the audited firm (financial reporting) (Goldman and Barlev 1974). 2 As long as client-specific quasi-rents can be earned, the auditor has an economics incentive to keep this client. Quasi-rents arise naturally in longer audit-client relation- ships, when the auditor invests in the current period with the expectation of return in future periods (Lee and Gu 1998). Substantial future quasi-rents are generated as the result of the start-up or learning costs of the initial audits and the rotation costs that all clients must incur when changing auditor. Furthermore, the economies of scale resulting from combining auditing and other services are an additional source of quasi-rents. It is true that the provision of service increases auditor quasi-rents that are specific to the client. With a positive initial investment in a new client, the future revenues must be higher than future costs in order that the auditor is interested in keeping the relation- ship with the client. Thus, the auditor has no incentives to tell the “truth” when the truth is “bad news” from the client’s perspective (DeAngelo 1981a, p. 116). However, if no client-specific quasi-rents are expected from a given client relationship, an au- ditor is indifferent to the termination of that relationship. Consequently; he has no economic incentive to conceal a discovered breach. In this case, the auditor is per- fectly independent with respect to that particular client. Thus, if contracting among the auditor and the client were costless, then auditors would always be perfectly inde- pendent from their clients. It follows that a necessary condition for a positive demand for costly auditing and less than perfect auditor independence is that contracting among auditor and clients be costly. However, when contracting is costly, incumbent auditors need to possess a com- parative advantage over their competitors in future periods, in order to expect to earn quasi-rents. Competition for initial auditing contracts leads many auditors to set the fees for their initial audit engagement below the total current costs (called “low-balling”) (DeAngelo 1981a, 1981b). Therefore, the competition for the “prop- erty rights” of incumbency forces auditors to “low ball” in the initial period. Thus, “low balling” is a competitive response to the expectation of future-quasi rents, and does not itself impair independence. In fact, it is the client-specific quasi-rents that are the necessary condition for impaired independence. 2 However, a parallel performance of audit and non-audit service to a client could also lead to information and cost benefits, which could increase the overall audit quality (e. g., Quick 2002). 13 Review of empirical research on rotation and non-audit services 215 3 Auditor independence regulation The need for financial regulation is often justified by the potential for market fail- ure that can result when managers possess inside information while investors do not (called “information asymmetry”), as well as from the inappropriate behavior of au- ditors, (called “moral hazard” 3 ). New laws that attempt to address these issues in the United States (Sarbanes-Oxley Act of 2002) and in the European Union (Council of the European Communities 2006) indicate that the predominant view among legisla- tors is that we need more regulation, more severe penalties, and larger enforcement budgets to protect financial markets from fraud. The Sarbanes-Oxley Act (SOX) of 2002 has been the most significant legislative response to corporate scandals such as Enron. The stated purpose of the act “is to pro- tect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes” (SOX 2002). As a correc- tive measure in light of significant accounting failures, SOX strongly reinforces the position of investors first defined by the Securities and Exchange Commission. This Act is applicable to publicly traded companies, and it created the Public Company Accounting Oversight Board under the supervision of the Securities and Exchange Commission (Title I). It also imposes greater restrictions and requirements in terms of auditor independence (Title II). The role, position, and liabilities of the statutory auditor within the European Union are inconsistently regulated by each Member State (Quick, Turley, and Willekens 2008). 4 However, the increasing number of important financial failures has led to a call for a minimum level of harmonization of the auditing function. There is an increasing belief that the lack of common practices and/or standards has a nega- tive impact on auditing quality and on the freedom to establish and provide services in the auditing field (European Commission 1996). Therefore, the European Commis- sion proposed a revised Directive, to ensure that investors and other interested parties could fully rely on the accuracy of audited accounts, and also to enhance common protection within the European Union. This might be an indication that harmoniza- tion on a voluntary basis was not fully effective. The 8th European Directive will be mandatory by June 2008 for the entire European Union (Council of the European Communities 2006). The revised 8th Directive states that Member States shall ensure that the auditor (or the key audit partner responsible for carrying out the audit on be- half of the audit firm) rotates from the audit engagement within a maximum period of five years (Article 40). SOX requires auditor and review partner rotation within the same timeframe. SOX makes it unlawful for a registered public accounting firm (or any person as- sociated with the firm, to the extent determined appropriate by the Securities and Exchange Commission) to provide to a client – contemporaneous with the audit – any non-audit service. This service may be in the form of bookkeeping, or other services related to accounting records or financial statements, financial information systems 3 For a detailed discussion on the need for regulation concerning financial reporting and accounting, see Watrin (2001). 4 For a review on auditor independence regulation is provided by Quick (2006). 13 216 C. Pott et al. design and implementation, appraisal or valuation services and fairness opinions; ac- tuarial services, internal audit services, management functions or human resources; broker-dealer services, legal services, and any other service that the board of direc- tors determines to be impermissible by regulation. However, a public accounting firm may engage in any non-audit service for an audit client (including tax services not described above) if the activity is approved in advance by the client’s corporate audit committee (SOX Section 201(a)). When a statutory audit is carried out in a Member State, the 8th Directive requires that the statutory auditor (or audit firm) be independent from the audited entity and not be in any way involved in management decisions of the audited entity. Further- more, a statutory auditor (or audit firm) is prohibited from conducting a statutory audit if it has any financial, business, employment or other relationships with the audited entity (including the provision of additional, non-audit services) that might compromise the independence of the statutory auditor (or audit firm) (Article 23.1). Likewise, as an example of how the profession has the ability to regulate itself and does not shy away from adopting a tougher stance on its members, the Inter- national Federation of Accountants (IFAC) issued a Code of Ethics for Professional Accountants (revised 2005). The Code is divided into three sections. The first in- cludes principles that are applicable to all professional accountants, while the second and third parts distinguish between those principles that affect professional accoun- tants in public practice and those that are applicable to other accountants employed in business and industry. These new rules of independence set out a conceptual framework that focuses on the factors that pose a threat to independence for all as- surance engagements, and the safeguards auditors should put in place to preserve their independence. In addition, the updated Code provides concrete examples of how the conceptual approach to independence is to be applied to specific circumstances and relationships. Thus we find situations of conflict being addressed, such as em- ployment with assurance clients, provision of non-assurance services to assurance clients including temporary staff assignments, recruiting of senior management, pro- vision of tax and legal services, and preparation of accounting records and financial statements. 4 Empirical research on auditor independence The taxonomy used to structure the empirical literature on auditor independence fol- lows the two major requirements of both SOX and the EU Directive: Research on auditor rotation and non-audit services. Furthermore, in contrast to other literature reviews (e. g., Schneider et al. 2006), we distinguish between empirical research re- lated to independencein fact and independencein appearance. Independence in fact is measured by the actual behavior of auditors, audit opinions issued, earnings manage- ment and quality, and restatements of financial data (Ewert 2003, p. 531). Following Ewert (2003), studies related to independence in appearance can be compared de- pending on whether the direct assessments of stakeholders or the association between the client’s earnings and capital market reaction and behavior related to the choice of auditor is measured as the dependent variable. We also indicate whether the stud- 13 Review of empirical research on rotation and non-audit services 217 ies were conducted in the US, Europe or elsewhere, in order to consider potential differences in findings related to jurisdictional differences. 4.1 Auditor rotation With increasing audit partner tenure, the relationship between auditor and her/his client might introduce a so-called familiarity threat to auditor independence (IFAC 2005). The IFAC Code of Ethics states that a “familiarity threat occurs when, by virtue of a close relationship with an assurance client, its directors, officers or em- ployees, a firm or a member of the assurance team becomes too sympathetic to the client’s interests” (IFAC 2005, p. 32). This threat may result in a decline in the audit partner’s ability to judge the company’s performance correctly. 5 A long relationship between audit partners and their clients might further influence the auditor’s independence and objectivity. In the early years of tenure an audit part- ner is most certain to be independent and to apply creative audit-testing approaches (AICPA 1978;Hoyle1978). With an increasing period of engagement, the audit programs may become routine, as a result of the auditors’ deeper knowledge of the client’s systems and control procedures (Hoyle 1978). Shockley (1981) asserts that “complacency, lack of innovation, less rigorous audit procedures and a developed confidence in the client may arise after a long association with the client.” The major concern then is that the auditors are anticipating the results on the basis of prior audit years, instead of being alert to detect material misstatements (Arrunadaand Paz- Ares 1997;Quick2004). Third, over time, the auditor’s incentives shift toward main- taining and profiting from the client and the audit. The prospect of “client-specific rents” that the auditor can extract only over time may create an economic dependency on the client, which impairs the auditor’s independence (DeAngelo 1981a, 1981b). The auditor expertise hypothesis is based on the information asymmetry between the client and the auditor, which is reduced over time as auditors acquire client- specific knowledge. Because increased client-specific knowledge provides a compar- ative advantage in detecting material misstatements in financial reports, the lack of this knowledge in the early years of an audit engagement may result in a lower quality audit (e. g., Beck, Frecka, and Solomon 1988; Geiger and Raghunandan 2002). 4.1.1 Research studies The rotation-related empirical literature, divided into studies on independence in fact and in appearance, is presented in Table 1. Furthermore, the research is classified based on whether the studies investigate audit firm rotation and audit firm tenure and/or audit partner rotation and audit partner tenure. Dopuch, King, and Schwartz (2001) observed that the highest frequencies of au- ditors’ selections of favorable reports, as a measure of the actual behavior of the auditor, occurred in regimes without mandatory audit firm rotation or retention. This 5 Opponents argue that a long audit partner association with a particular client results in higher audit qual- ity. Myers et al. (2003) emphasize the higher audit costs in the early periods of audit tenure and the increase in client and industry knowledge gained over repeated audits. 13 218 C. Pott et al. Table 1 Research related to rotation and tenure Jurisdiction Author(s) (Year) Measure Results Supportive Not supportive Auditor Independence in Fact Audit Firm Rotation Measure of auditor independence in fact: actual behavior of auditor USA Dopuch et al. (2001) Auditors‘ willing- ness to issue reports biased in favour of management Rotation requirements decreased auditor-subjects’ willingness to issue biased reports, relative to the two regimes on which rotation was not imposed Managers also made higher investments than predicted in these non-retention, non-rotation regimes, thereby raising the probabilities they would have high assets Audit Firm Tenure Measure of auditor independence in fact: audit opinion issued USA Geiger & Raghunandan (2002) Audit Report preceding bankruptcy Indication that audit reporting failures are more likely to happen in the earlier years of the auditor-client relationship than when the auditors had served these clients for longer tenures Belgium Knechel & Vanstraelen (2007) Going-concern audit opinions Auditors do not become less independent over time Measure of auditor independence in fact: earnings management and quality USA Myers et al. (2003) Abnormal accruals and current accruals Longer auditor tenure results in auditor placing greater constraints on extreme management decisions in the re- porting of financial performance USA Davis et al. (2007) Abnormal accruals Firms with both short (two to three years) and long (13–15 years or more) tenure are more likely to report levels of discretionary accruals that allow them to meet or beat earnings forecasts USA Carcello & Nagy (2004) Companies’ cita- tion for fraudulent financial reporting Fraudulent financial reporting is more likely to occur In the first three years of the auditor-client relationship; no evidence that fraudulent financial reporting is more likely given long auditor tenure 13 [...]... dependent on what sample is used, and in all probability on how the research instrument is constructed Therefore, research on auditor independence perceptions related to non-audit services has to be carefully interpreted Overall non-audit service fees can impair auditor independence in appearance In comparison, research on independence in fact finds mixed results on impairment from non-audit services In particular,... Measure of auditor independence in appearance: assessments of stakeholders USA Jenkins & Perceptions of auditor Krawczyk independence (2003) USA Mauldin (2003) Perceptions of auditor Professional investors perceive that independence independence is impaired when the auditor provides internal audit services or merger and acquisition services Going-concern modified audit opinion USA Craswell et al Going-concern... Jurisdiction Author(s) (Year) Table 2 Review of empirical research on rotation and non-audit services 229 13 13 Measure USA Supportive Krishnan et al Earnings response co- Negative association between non-audit fees and (2005) efficient the earnings response coefficient Measure of auditor independence in appearance: behavior related to the choice of auditor USA Raghunandan Proportion of share- Proportion of. .. votes against auditor (2003) holder votes against ratification is positively associated with the relaauditor ratification tive magnitude of the non-audit fee ratio Jurisdiction Author(s) (Year) Table 2 continued Results Not supportive 230 C Pott et al Review of empirical research on rotation and non-audit services 231 earnings-response coefficients, when the level of non-audit services acquired from industry... going-concern au- sity to issue going-concern opinion) increased the dit opinions propensity to miss analysts’ forecasts and led to higher earnings-response coefficients when the level of non-audit services acquired from industry specialist auditors was compared to that acquired from non-specialist auditors USA DeFond et al Auditor s propensity to (2002) issue going-concern audit opinions Measure Research. .. receive a going-concern modified audit opinion Hay, Knechel, and Li (2006) examined evidence in New Zealand about whether auditors providing more non-audit services are less independent The results of the logistic regression test of the relation between audit opinion and the level of non-audit fees show that there is no significant relation between audit qualification or modification and non-audit fees... related to non-audit service fees Jurisdiction Author(s) (Year) Table 2 Not supportive No evidence that non-audit service fees impair auditor independence Significant negative association between the non-audit service to total fee ratio and the absolute value of accruals Results Review of empirical research on rotation and non-audit services 227 13 continued 13 Hay et al (2006) Sharma (2001) Sharma and Sidhu... research on non-audit services and auditor independence in fact does not indicate a benefit to prohibiting the provision of non-audit services for a financial statement audit client Different studies using audit opinion issued as a proxy for auditor independence draw different conclusions Some studies argue that a decrease in the propensity that a going-concern audit opinion is issued together with an increase... Parts 210 and 240 File No S 7-1 3-0 0 Government Printing Of ce, Washington, DC Sharma DS (2001) The association between non-audit services and the propensity of going concern qualifications: Implications for audit independence Asia-Pac J Account Econ 8(2):143–155 Sharma DS, Sidhu J (2001) Professionalism vs commercialism: The association between non-audit services (NAS) and audit independence J Bus Finan Account... Watrin et al Abnormal accruals and (2008) current accruals Audit Partner Tenure Measure of auditor independence in fact: audit opinion Australia Carey & Audit opinion, abnorSimnett (2006) mal working capital accruals and beating (missing) earnings benchmarks Germany Australia Jurisdiction Author(s) (Year) Table 1 continued 220 C Pott et al Review of empirical research on rotation and non-audit services . DOI 10.1007/s1130 1-0 0 9-0 04 3-0 STATE -OF- THE-ART-ARTIKEL Review of empirical research on rotation and non-audit services: auditor independence in fact vs. appearance Christiane Pott · Theodore J bans on providing concurrent non-audit services were implemented to maintain auditor independence, both in fact and in appearance. However, the implementation of audit regulation implies that increased. newest empirical research re- lated to audit partner rotation and non-audit services and independence in fact or in appearance. Overall, we conclude that prior research does not point to one particu- lar