Nonaudit Fees, Auditor Independence, and Bond Ratings

Abstract

Recent accounting scandals and perceived audit failures have resulted in excessive criticism of the accounting and auditing professions. The financial press has expressed disdain at the presumably substandard work that was completed on audit clients, ostensibly at the expense of the public good. Our research investigates one aspect of this situation by exploring the effects that nonaudit services performed by a firm's external auditors have on perceived auditor independence in the bond market. Specifically, we analyze the effects that the magnitude and relative degree of nonaudit services have on the bond rating process. Regression results indicate that the amount of nonaudit services provided by a firm's external auditors is negatively associated with that client's bond rating. However, results of classification accuracy analyses fail to demonstrate any improvement in performance as a consequence of adding nonaudit fees to a benchmark prediction model, indicating no economic effect on the actual bond ratings. These results afford insights concerning bond rating analysts' perceptions of auditor independence and provide empirical evidence regarding the role that audit and nonaudit service fees play in establishing a firm's bond rating.