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Does Client Importance Affect Auditor Independence at the Office Level? Empirical Evidence from Going Concern Opinions

Chan Li Joseph Katz Graduate School of Business University of Pittsburgh, Pittsburgh, PA 15260 chanli@katz.pitt.edu

412-648-1723

I gratefully acknowledge the helpful comments and suggestions of Michael Willenborg (associate editor) and two anonymous reviewers. This paper is based on my dissertation, completed at the University of Kansas. I appreciate helpful suggestions and insights of my dissertation committee: James Heintz, Rajendra Srivastava, Todd Little, and especially Mike Ettredge (Chair) and Susan Scholz. I also thank Harry Evans, Mei Feng, Vicky Hoffman, Karla Johnstone, Kenneth Reynolds, Kathy Rupley and participants in the workshops at George Washington University, Georgia Institute of Technology, Miami University, Oregon State University, State University of New York at Buffalo, Temple University, University of Pittsburgh, University of Texas-San Antonio, and participants at the 2007 AAA midyear auditing conference.

Electronic copy available at: http://ssrn.com/abstract=1108189

Abstract

This paper investigates whether client importance affects auditor independence within the local offices of audit firms. Client importance is measured as the proportion of audit fees, non-

audit service fees, or total fees that a distressed, public client contributes to the total public-client revenue earned by the individual audit offices. Auditor independence is measured as the auditor’s propensity to issue a going-concern opinion. The paper focuses on changes in the relation between fee ratios and auditor reporting decisions from the pre-SOX (2001) to post-SOX (2003) period. In the pre-SOX period, I do not find statistically significant association between any of the fee ratios and the auditor’s propensity to issue a going concern opinion. However, in the post-SOX period, I find evidence that higher audit fee and total fee ratios are positively associated with the auditor’s propensity to issue a going concern opinion. That is, post-SOX,

relatively more important clients are more likely to receive a going concern opinion.

results allay concerns that auditor independence is compromised for significant clients.

These

Key Words: auditor independence, going concern, audit fee, non-audit fee.

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Electronic copy available at: http://ssrn.com/abstract=1108189

Does Client Importance Affect Auditor Independence at the Office Level? Empirical Evidence from Going Concern Opinions

1. Introduction

This study addresses the question of whether auditors are less likely to act independently

when dealing with larger, more economically significant clients. I examine whether the exercise

of auditor independence, proxied by the auditor’s willingness to issue a going concern opinion, is

associated with the proportion of audit fees, non-audit service fees, or total fees a distressed,

public client contributes to the total public-client fees earned by an individual audit office. I also

investigate the impact of the Sarbanes-Oxley Act (SOX) on auditor independence by comparing

the effect of client importance on auditor reporting decisions during the pre-SOX (2001) versus

post-SOX (2003) periods.

Auditor independence has come under increased scrutiny over the past several years

because of highly publicized accounting scandals, allegedly associated with audit failures and with

the growing amount of non-audit service fees that audit firms receive from audit clients. Some

observers contend that large non-audit service fees can cause auditors to become financially

dependent on their clients (e.g., Levitt 2000). Several studies examining fees and investors’

perceptions of auditor independence document that when independence-in-appearance has been

impaired (i.e., when auditors receive large non-audit fees from clients), the perception of auditor

independence is damaged (Krishnan et al. 2005; Francis and Ke 2006; Krishnamurthy et al. 2006;

Khurana and Raman 2006). To address the threat to auditor independence posed by non-audit fees,

in 2001 the U.S. Securities and Exchange Commission (SEC) began to require public companies

to disclose audit and non-audit service fees in their proxy statements. The SEC also limits the

circumstances under which an audit firm can provide financial information system design and

implementation (FISDI) services, and sets monetary limits on fees for internal audit services (SEC

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2000). After the Enron and WorldCom scandals and the collapse of Arthur Andersen, Congress

passed the Sarbanes-Oxley Act of 2002 (SOX), which banned audit firms from providing FISDI,

internal audit, and “certain other services” to their audit clients. Recently, the Public Company

Accounting Oversight Board issued guidance restricting the scope of acceptable tax planning

services in response to alleged overly aggressive tax planning by several large accounting firms

(PCAOB 2005).

Collectively, these actions indicate a concern among regulators and investors that some

auditors may compromise their audit independence in exchange for large amounts of non-audit

services fees from their audit clients. However, previous empirical studies have generally failed to

detect a negative association between non-audit or audit fees and proxies for auditor

independence-in-fact (e.g. DeFond et al. 2002; Ashbaugh et al. 2003; Kinney et al. 2004; Larcker

and Richardson 2004). Some studies have even reported a positive association (Reynolds and

Francis 2001; Geiger and Rama 2003).

Most prior studies on auditor independence focus on independence at the national audit

firm level. However, recent research suggests that auditor incentives and economic dependence

may be better captured at the local office level, because local offices contract with clients,

administer audits, make audit decisions, and issue audit reports. Moreover, for an individual office

of an audit firm, a single client can represent a large portion of office-level revenues, yet play a

much smaller economic role at the national audit firm level (Francis et al. 1999). Thus, the

economic impact of large clients is potentially more important to the engagement office’s well-

being than to the audit firm as a whole (Francis et al. 1999; Reynolds and Francis 2001).

Several audit firm office-level studies have examined auditor independence using either

client sales data (Reynolds and Francis 2001) or non-US fee data (Craswell et al. 2002; Ferguson

et al. 2004) to proxy for client influence. Studies using non-US fee data have examined separately

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the effects of audit fees and non-audit fees on auditor independence. However, if the overall

auditor-client economic bond creates the primary threat to auditor independence, then total fees

would seem an important measure. Both audit and non-audit fees can contribute to the economic

bond as both are paid to the auditors (DeFond and Francis 2005; Francis 2006). Current data

suggest that while non-audit fees have recently declined, audit fees have simultaneously increased

dramatically (e.g. Asthana et al. 2004; Weil 2004; Gullapalli 2005). Thus, examining the

combined effect of audit and non-audit fees effectively captures the overall potential threat to

auditor independence. In addition, while previous studies have examined pre-SOX data, SOX

specifically banned certain non-audit services to address regulators’ and investors’ concerns over

auditor independence. Therefore, to the extent that auditor independence was compromised before

SOX, it is important to examine whether the association between fees and auditor independence

changes after SOX implementation. This study extends prior research by including post-SOX data

at the local office level.

Following prior research, I focus on distressed firms, because the going concern decision is

more salient among this group (Hopwood et al. 1994; Mutchler et al. 1997; DeFond et al. 2002). I

analyze 1,681 distressed firms in 2001, of which 126 receive first-time going concern audit reports;

and 1,780 distressed firms in 2003, of which 108 receive first-time going concern audit reports. I

focus on firms receiving first-time going concern opinions because previous studies suggest that

rendering an initial going concern opinion to a client is a particularly difficult decision for the

auditor (Kida 1980; Mutchler 1984). The ratios of client audit fees, non-audit fees, or total fees to

total audit office fee revenue are included in logistic regressions that analyze the determinants of

going concern opinions. Observing negative relations between fee ratios and going concern

opinions is consistent with the concern that auditors receiving larger audit fees are less likely to act

independently by issuing a going concern opinion.

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Consistent with prior literature (e.g. DeFond et al. 2002; Craswell et al. 2002), I find no

statistically significant associations between any of the fee ratios and the auditor’s propensity to

issue a going concern opinion in the 2001 pre-SOX period. However, in the 2003 post-SOX period,

I find that the audit fee ratio and the total fee ratio are positively associated with the auditors

propensity to issue going concern opinions. That is, clients paying higher audit and total fees are

more likely to receive a going concern report. Further, this relation is driven primarily by Big 4

auditors. None of these results support concerns that higher fees create problematic economic

dependence for auditors with respect to their going concern decisions. Instead, they are consistent

with market and regulatory incentives, such as firm reputation preservation and litigation risk

avoidance, protecting auditor independence.

The remainder of the paper is organized as follows. Section 2 provides a review of

relevant prior research. Section 3 develops the research question and hypotheses. Section 4

describes the research methods and section 5 presents the results. Section 6 summarizes my

findings.

2. Review of prior research

Auditor independence can be defined as the joint probability that the auditor will detect

and report a discovered breach in the financial reports (DeAngelo 1981; Watts and Zimmerman

1983). A large body of theoretical and empirical research suggests that because of reputation

concerns and litigation costs, auditors have both market-based and institutional incentives to act

independently (Watts and Zimmerman 1983; Palmrose 1988; Krishnan and Krishnan 1997).

However, there are also forces that potentially threaten auditor independence (DeFond et al. 2002).

DeAngelo (1981) develops a model where an auditor faces a conflict of interest. The incentives for

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the auditor to compromise independence are related to client importance, the ratio of quasi rents

specific to the client divided by all other quasi rents. 1

Empirical research examining the relationship between fees (audit and non-audit) and

proxy for impaired independence at the national level generally fails to find significant

associations. The measures of impairment in these studies include earnings attributes, earnings

restatements, and auditor reports (e.g. DeFond et al. 2002; Ashbaugh et al. 2003; Kinney et al.

2004). At the office level, Chung and Kallapur (2003) also find no relation between absolute

discretionary accruals and non-audit fee and total fee ratios using a surrogate measure for audit

practice office revenue. They estimate the surrogate measure by allocating an audit firm’s total

revenue to its audit offices in proportion to the sum of log(sales) of each office’s clients.

Some studies do report significant associations, although the relations have differing

interpretations. For example, Gaver and Paterson (2007) examine insurance firms and find that

the tendency of financially weaker insurers to understate reserves is significantly reduced when

they are economically important to the audit office. In contrast, using a sample of U.K. firms,

Ferguson et al. (2004) find that the decile rank of a particular client’s non-audit service fees is

associated with more discretionary accruals and the likelihood of restatements. Similarly,

Basioudis et al. (2006) find, after controlling for office-level influence of audit clients, that higher

non-audit fees are associated with fewer going-concern reports for U.K. financially stressed

companies. Table 1 summarizes the findings of prior literature on fee dependence and auditor

independence.

------------- Insert Table 1 here --------------

1 Empirically, the quasi-rent ratio is unobservable (Chung and Kallapur 2003). Client importance generally is measured as the ratio of fees from a client divided by the audit firm’s total revenue (Chung and Kallapur 2003; Larcker and Richardson 2004)

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Two prior studies are particularly relevant to this study because both examine the relation

between client importance at the office level and auditor reporting decisions. Craswell et al. (2002)

use Australian data in 1994 and 1996 to examine the association between audit fee dependence,

measured as the ratio of client audit fees to total audit office fees, and the propensity to issue

qualified audit opinions. They report no association between audit fee dependence and qualified

audit opinions. Their study focuses on serious opinion qualifications, such as the auditors’

inability to form an opinion, inherent uncertainty underlying the accounting numbers, adverse

opinions, or scope limitations. Reynolds and Francis (2001) use 1996 data to examine whether

large clients influence office-level auditor reporting decisions by Big 5 auditors. Client influence

is measured as the proportion of the client’s net sales to the total net sales of all clients audited by

the report-issuing office. They find client influence is negatively associated with discretionary

accruals, and positively associated with auditor going-concern reports. Their results suggest that

Big 5 auditors report more conservatively for their larger clients. This is consistent with the notion

that, when making reporting judgments, auditors are more concerned with protecting their

reputations (reputation protection theory), rather than influenced by important clients (economic

dependence theory).

This study extends these two studies in the following ways. First, I use the proportion of

audit fees, non-audit fees, and total fees contributed by the specific client to the local office’s total

fees. Second, I use both pre- and post-SOX data to provide evidence on the efficacy of SOX in

mitigating the potential auditor independence problems.

3. Hypothesis development

Client importance and going concern opinions

Prior research shows that clients receiving going concern opinions experience negative

market reactions (Loudder et al. 1992; Blay and Geiger 2001) and increased risk of business

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failure (Geiger et al. 1998). As a result, clients receiving going concern opinions are more likely to

change auditors in hope of finding a more pliable auditor and receiving more favorable treatment

(Mutchler 1984; Geiger et al. 1998). The impact of losing an important client is arguably more

important to the engagement partner and the local office’s well-being than to the audit firm as a

whole (Reynolds and Francis 2001; DeFond and Francis 2005). Following this, local offices

should have a greater economic dependence on a large client than the overall firm, and are thus

more likely to treat such clients favorably.

However, local offices also have incentives to protect their reputation and to reduce their

litigation risk. Questionable audits can impair an office’s reputation and adversely affect its ability

to obtain and retain clients in its local market (Reynolds and Francis 2001). While economic

dependence arguably exists for large clients, these clients also pose greater litigation risk (Stice

1991; Lys and Watts 1994). Carcello and Palmrose (1994) provide evidence that for bankrupt

clients, prior modified audit reports could serve to weaken plaintiff’s claims against auditors.

Therefore, it is unclear whether the economic bond between auditors and important

distressed clients will dominate the reputation and litigation effects for local offices, especially in

the pre-SOX period, when the litigation risk was relatively lower. The above arguments lead to the

first hypothesis (stated in the null form):

H1: There is no association between auditors’ propensity to issue going concern opinions

and the economic importance of distressed clients to their local office.

Client importance is measured as the ratio of the individual clients audit fees, non-audit

fees, and total fees to the total fee revenue of a local practice office. Observing a negative

association between the fee ratios and going concern opinions would provide support for the

economic dependence theory.

Effects of SOX

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After the events of 2002 (e.g. the collapse of Andersen, the passage of SOX, and the new

oversight by PCAOB), the risk associated with auditing increased dramatically. For example, the

change of regulatory authority for public company engagements from the private sector AICPA to

the quasi-governmental PCAOB increased regulatory risk to audit firms, due to the likely advent

of tougher standards and inspections (Johnstone and Bedard 2007). 2 The insurance- and other

liability-related costs also increased significantly in the post-SOX period (Rama and Read 2006).

To mitigate the increased litigation risk and protect reputation capital in this era, auditors either

resign from risky clients (Rama and Read 2006), require their clients to recognize bad news in a

timely fashion (Krishnan 2007), or increase risk responsiveness in planning the extent of audit

tests (Johnstone and Bedard 2007).

Prior studies suggest that when clients pay large amounts of non-audit or total fees,

investors react negatively (Krishnan et al. 2005; Francis and Ke 2006; Krishnamurthy et al. 2006;

Khurana and Raman 2006). Thus, auditors may come under greater scrutiny when they conduct

audits for important clients, which would lead auditors to focus more on maintaining

independence-in-fact. This will be especially true in the post-SOX era because of the heightened

litigation environment and the ban on certain non-audit services after the passage of SOX. Geiger

et al. (2005) find that auditors in general are more likely to issue going-concern opinions after

December 2001, consistent with the view that auditors report more conservatively in the post-SOX

period. The response letters of the Big 4 accounting firms to the PCAOB Inspection Reports also

indicate that they made organizational and structural changes after SOX. 3 In fact, the U.S.

Treasury Secretary expressed concern that auditors may have become overly strict with clients

2 The inspections from PCAOB are much more punitive in nature than the peer reviews that are primarily corrective in nature (Read et al. 2004; Rama and Read 2006).

3 For example, KPMG in the 2005 response letter states :“we have further strengthened our commitment to quality, made fundamental changes to our business and landmark improvements to our risk management structure; and put cultural and governance reforms into effect that reflect the highest ethical standards.” The PCAOB’s inspection reports are available from the following website: http://www.pcaobus.org/Inspections/Public_Reports/index.aspx

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after SOX (Solomon 2007). Therefore, I expect to find auditors less lenient towards influential

clients in the post-SOX period. My hypothesis related to the SOX effect is (stated in the

alternative form):

H2: Auditors are more likely to issue going concern opinions to distressed clients that are

of greater economic importance to their local office in the post-SOX period.

4. Research method

Sample

To calculate the proportion of audit fees, non-audit fees, and total fees of a specific client

to a local office’s total revenue, I obtain a sample of public companies having necessary office

location and fee data in the Audit Analytics Database. This process results in a sample of 6,473

client companies in 2001 and 11,313 client companies in 2003. Sample companies must also have

necessary financial information available from Compustat, which reduces the sample to 4,573

companies in 2001 and 5,844 companies in 2003. 4 Following prior research (DeFond et al. 2002;

Geiger and Rama 2003), I restrict my analyses to financially distressed companies and first-time

going concern receivers. Financially distressed firms are defined as firms that report either

negative net income or negative operating cash flows during the current fiscal year (Reynolds and

Francis 2001; DeFond et al. 2002). 5 Finally, I delete all financial institutions. These steps yield a

final sample of 1,681 test companies in 2001, including 126 that receive first-time going concern

4 The sample difference between 2001 and 2003 is mainly due to missing fee data in 2001. I randomly check 50 companies’ proxy statements in 2001, and find that although the SEC requires companies to disclose fee information in their post-Feburary 5, 2001 proxy statements, some companies don’t disclose, and most of the non-disclosure companies are small (with average revenue of $3.7 million compared to $635.1 million for companies that disclosed fee data in 2001). Similarly, the companies without financial information from Compustat are also likely to be small. Because small companies are less likely to be important, but are more likely to be distressed, missing small companies in the sample could potentially bias against finding a negative association between client importance and auditor going concern opinions.

5 I also define financially distressed companies as reporting both negative earnings and negative operating cash flows. Sample size decreases to 810 from 1,681 in 2001, including 97 companies receiving first-time going concern opinions, and decreases to 898 from 1,780 in 2003, including 80 first-time going concern companies. Results indicate that none of the fee ratios are significant in regressions for either 2001 or 2003.

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opinions, and 1,780 test companies in 2003, including 108 that receive first-time going concern

opinions.

Research Model

The following logistic model is used to test the hypotheses. All variables are measured in

fiscal year 2001 or 2003, unless specified otherwise.

GC = b 0 + b 1 AUDFEE / NONAUDFEE / TOTALFEE + b 2 SALES + b 3 ROA +

b 4 LEVERAGE + b 5 LIQUIDITY + b 6 CHGDT + b 7 PRLOSS + b 8 PRNOCF +

b 9 BIG N + b 10 DELAY + b 11 NEWDEBT

where:

GC

(1)

= 1 for companies receiving first-time going concern opinions, 0 otherwise.

AUDFEE / NONAUDFEE / TOTALFEE = client audit fees / non-audit fees / or total fees, each divided by the total revenue of the local office that issues the audit report.

SALES

= natural logarithm of client’s total sales at the end of the year.

ROA

= net income divided by total assets at the end of the year.

LEVERAGE

= total liabilities divided by total assets at the end of the year.

LIQUIDITY

= total current assets divided by total current liabilities at the end of the year.

CHGDT

= the change in long-term debt divided by total assets, from year 2000 to 2001(or 2002 to 2003).

PRLOSS

= an indicator variable equal to 1 if the company reported negative net income in the prior year (2000 or 2002), 0 otherwise.

PRNOCF

= an indicator variable equal to 1 if the company reported negative operating cash flows in the prior year (2000 or 2002), 0 otherwise.

BIG N

= an indicator variable equal to 1 if the auditor is Big 4 (5), 0 otherwise.

DELAY

= number of days between fiscal year-end and the auditor’s report signing date.

NEWDEBT

= 1 if the company issues new debt in the subsequent year (2002 or 2004), 0 otherwise.

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AUDFEE, NONAUDFEE and TOTALFEE are the test variables. AUDFEE and

NONAUDFEE are used in one model, TOTALFEE in the other. If higher fees impair auditor

independence, i.e., if the economic bond between auditors and important distressed clients

dominates the reputation and litigation effects, their coefficients should be negative.

The model controls for the effects of other factors that likely affect auditors’ probability of

issuing going concern opinions: client size, extent of financial distress, audit firm size, audit

reporting lag and client new financing.

Prior research finds a negative relation between a company’s size and its likelihood of

receiving a going-concern opinion after controlling for the relation between size and bankruptcy

(McKeown et al. 1991; Mutchler et al. 1997). This result could arise because auditors think large

companies have more resources to avoid bankruptcy (Mutchler et al. 1997), or because large

companies have more negotiation power with auditors in the opinion decision process (McKeown

et al. 1991). I expect a negative association between SALES and GC.

Financial distress factors include ROA, LEVERAGE, CHGDT, LIQUIDITY, PRLOSS

and PRNOCF. I use net income divided by total assets (ROA) and total liabilities divided by total

assets (LEVERAGE) to control for companies’ financial conditions. LIQUIDITY is measured as

the current ratio and is used to control for companies’ liquidity risk. Mutchler et al. (1997) find

that debt covenant violations are positively related to the probability of receiving a going concern

opinion. I include CHGDT because increases in debt are likely to move companies closer to

violations (Reynolds and Francis 2001). Alternatively, CHGDT can proxy for the ability to raise

additional debt capital in the future, and hence funding viability. PRLOSS and PRNOCF are

included because firms with multiple-year negative operating cash flows or negative net incomes

are more likely to fail (Reynolds and Francis 2001; DeFond et al. 2002). I expect negative

associations between ROA and GC, as well as between LIQUIDITY and GC. I expect positive

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associations between LEVERAGE, PRLOSS, PRNOCF and GC. I do not have a directional

prediction on the association between CHGDT and GC.

Large auditors have more quasi-rents at stake if there is a questionable audit (DeAngelo

1981). They are also likely to suffer more reputation loss due to their larger investment in

reputation capital. Thus large auditors may be more likely to issue going concern opinions,

although prior studies find inconsistent results (e.g. Mutchler et al. 1997; Behn et al. 2001;

DeFond et al. 2002; Geiger and Rama 2003). Auditor type is measured as a dichotomous variable:

Big N versus non-Big N. I expect a positive association between BIG N and GC.

I include audit report lag (DELAY) because prior research finds that going concern

companies are associated with longer reporting lags (McKeown et al. 1991; Mutchler et al. 1997).

I expect a positive relationship between DELAY and GC. In addition, I control for clients’ plans

to issue new debt because Mutchler et al. (1997) find that new financing can reduce the probability

of bankruptcy. Behn et al. (2001) also note that auditors may view clients’ new borrowing as

evidence that the company has the capability to meet loan requirements in the near term. I expect a

negative relationship between NEWDEBT and GC.

5. Results

Descriptive statistics

Table 2 presents descriptive statistics for financially distressed public companies in 2001

and 2003 (Panels A and B, respectively). In 2001, distressed clients’ total fees average 9.5 percent

of all office-level revenue, audit fees contribute 5.2 percent, and non-audit fees contribute 4.3

percent. In 2003, the overall average contributed by distressed companies is similar, 9.7 percent,

but audit fees now contribute 7.5 percent, while non-audit fees contribute only 2.2 percent. The

change in both the audit and non-audit fee ratios is statistically significant (p-values are less than

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0.001.) The increase in post-SOX audit fees is consistent with those noted in recent studies

(Gullapalli 2005; Ettredge et al. 2007).

Table 2 also compares fee ratios of clients receiving first-time going concern opinions to

those receiving clean opinions. In 2001, the differences between the two groups are mainly

insignificant for all three fee ratios. The one exception is the median test for the non-audit fee

ratio, where non-audit fees are significantly higher for clients not receiving a going concern report.

This result is consistent with concerns that clients contributing more non-audit fees receive more

lenient treatment in the pre-SOX period.

In contrast, in 2003, the difference between the non-audit fee ratios is not significant.

However, the audit fee and total fee ratios are significantly higher for those receiving going

concern opinions. This evidence is consistent with auditors in the post-SOX environment being

more willing to issue unfavorable audit opinions to clients paying more fees, particularly audit

fees. Thus, the 2003 univariate results do not support economic dependence concerns. Rather, this

pattern is consistent with either increased conservatism in auditor going concern reporting post-

SOX, or with auditors performing more audit work for clients perceived to be more troubled. Of

course, these possibilities are not mutually exclusive.

Regarding control variables, in both years companies receiving going concern opinions are

smaller, have lower ROA, are more highly leveraged, have higher liquidity risk, are more likely to

report negative net incomes and negative operating cash flows in the prior year, and experience

longer audit report lags. These results are consistent with prior studies (e.g. Mutchler et al. 1997;

DeFond et al. 2002). However, the univariate results indicate that Big N auditors issue fewer

going concern opinions. This result may be due to the clientele differences between auditor types.

For instance, the average client revenue for Big N auditors is $996 and $792 million in 2001 and

2003, compared to $241 and $62 million for non-Big N auditors. The main difference between

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2001 and 2003 is that in 2003 going concern companies are also less likely to issue new debt in

the subsequent year.

------------ Insert Table 2 here -----------

Table 3 presents the correlation tables for the dependent and independent variables. In both

2001 and 2003, the three fee ratios are highly correlated with each other. Although the correlations

of several variables are above 0.35, the highest variance inflation factor (VIF) observed in

regressions is 1.88 in 2001 and 2.12 in 2003, which is well below the suggested multicollinearity

problem threshold of ten (Marquandt 1980; Gujarati 1995). Examination of standard errors and

coefficient magnitude also indicates the regressions are not sensitive to inclusion or exclusion of

the highly correlated variables. Thus, multicollinearity is unlikely to be a problem (Hosmer and

Lemeshow 1989).

------------ Insert Table 3 here -----------

Logistic regression results

Table 4 presents logistic regression model results for 2001 (Panel A) and 2003 (Panel B).

Two models are presented for each year. Model (1a) includes AUDFEE and NONAUDFEE as the

test variables, and Model (1b) tests TOTALFEE. All four models are highly significant at the

0.001 level.

Test variables

In 2001, none of the fee ratio coefficients is significant. However, in 2003, both AUDFEE

and TOTALFEE are positively associated with the presence of a going concern opinion (p-values

< 0.05), while NONAUDFEE remains insignificant. 6 Consistent with univariate results, these

6 I also examine the impact of each category of non-audit service fees: audit-related, FISDI, tax and other service fees. Results indicate none of these categories is associated with the auditor’s propensity to issue a going concern opinion in either 2001 or 2003. (The FISDI fee variable is not included in regressions for 2003, as SOX banned auditors from providing this type of service).

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regression results suggest that in 2003, but not 2001, clients contributing relatively more audit fees

to the local office are more likely to receive a going concern report.

To assess the significance of the temporal switch from pre- to post-SOX, I use an analog of

the Chow test for logistic regression (Allison 1999; DeMaris 2004). 7 The Chi-square test results

(untabulated) indicate that the change in audit and total fee coefficients between 2001 and 2003 is

not statistically significant.

Overall, this evidence does not support the concern that auditor independence is impaired

for significant clients. Rather, results are consistent with the argument that reputation effects and

potential litigation costs prevent leniency for such clients (e.g. Reynolds and Francis 2001;

DeFond et al. 2002). In fact, 2003 results suggest that post-SOX, auditors may be more

conservative when issuing going concern reports for important distressed public clients. This may

be due to a perception of heightened audit risk in this post-scandal, post-SOX period, since larger

clients tend to pose a greater litigation risk (Stice 1991; Lys and Watts 1994). An alternative

explanation for this result is that post-SOX, auditors perform additional work for clients receiving

first-time going concern reports, and this additional effort is reflected in audit fees, but not fully

controlled by other model variables.

Control variables

Consistent with prior literature, going concern companies are smaller, have less liquidity,

and experience longer audit report lags in both 2001 and 2003. Big N auditors tend to issue more

going concern reports in 2001 than non-Big N auditors, although there is no such distinction in

2003. Similarly, LEVERAGE, CHGDT, and PRNOCF are significant in 2001, but not in 2003. In

2001, companies with higher leverage and prior year negative operating cash flows are more likely

7 The test statistic is Chi-square = -2lnL c [-2lnL 1 + (-2lnL 2 )], where lnL c is the fitted log-likelihood for the combined sample, lnL 1 is the fitted log-likelihood for group 1 (pre-SOX), and lnL 2 is the fitted log-likelihood for group 2 (post- SOX).

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to receive a going concern opinion. However, going concern companies tend to report smaller

increases in long-term debt (CHGDT), likely because lenders do not consider such companies to

be acceptable credit risks. ROA, PRLOSS, and NEWDEBT are significant in 2003, but not in

2001. In 2003, companies with lower ROA and prior year negative net incomes are more likely to

receive a going concern opinion. Companies that issued new debt in the subsequent year are less

likely to receive a going concern opinion.

------------ Insert Table 4 here -----------

Recapping test results, logistic regression results show no statistically significant

association between going concern reports and the audit fees, non-audit fees or total fees

contributed by a client to the total revenue of their auditors’ local office in 2001. However, in

2003, clients contributing a greater proportion of audit and total fees are more likely to receive a

going concern report. One explanation for these results is that auditors may report more

conservatively in 2003 on significant, distressed public clients. These results complement the

findings of Geiger et al. (2005), who find evidence that auditors report more conservatively on all

distressed public firms in the post-SOX period. However, as noted above, the change in audit and

total fee coefficients between 2001 and 2003 is not statistically significant. The next section

further investigates this finding and considers alternative explanations.

Additional analyses

This section further explores the role of auditor type in issuing going control reports. 8 It

also provides additional analyses to investigate the possibility that the positive association

between fees and going concern reports in 2003 is attributable to additional audit effort expended

on going concern clients.

Auditor Type

8 I thank the associate editor for suggesting this analysis.

16

In regressions reported in Table 4, Big N auditors are more likely to issue going concern

reports in 2001, but not in 2003. It is possible that this change is due to Big N auditors realigning

their portfolios between 2001 and 2003 to reduce their exposure to risky clients. To assess any

effects of such a selection bias, I use a treatment effects model. 9 Results are similar to those

shown in Table 4 for both 2001 and 2003 after considering the effects of selectivity.

As an additional analysis of auditor type, I examine the model separately for Big N and

non-Big N clients. (Big N auditor is not included as a control variable in these models.) If

expected litigation risk and reputation loss are strong incentives for auditors to maintain their

independence, I expect the association between fee ratios and going concern opinions to vary by

auditor type, because expected litigation costs and reputation loss are greater for large auditors,

especially in the post-SOX period (Rama and Read 2006; Ashbaugh-Skaife et al. 2007).

Table 5, Panel A reports results for Big N and non-Big N clients separately in 2001, while

Panel B shows results for 2003. In 2001, all fee ratios are insignificant for both Big N and non-Big

N clients. In 2003, AUDFEE and TOTALFEE for Big N clients are significantly positive (p-

values < 0.05), and are marginally significant for non-Big N clients (p-values < 0.10). More

importantly, the Chow test analog indicates significant changes in the association between fee

ratios and going concern opinions from 2001 to 2003 for Big N clients, but not for non-Big N

clients. 10 Specifically, compared to 2001, Big N auditors in 2003 are three percent more likely to

issue going concern opinions when audit fee ratios change by one standard deviation, and are one

percent more likely to issue going concern opinions when total fee ratios change by one standard

9 Following Weber and Willenborg (2003), the first stage of the treatment effects analysis is to model auditor choice. The first stage model is BIG4 = b 0 + b 1 SALES + b 2 ROA + b 3 LEVERAGE + b 4 LIQUIDITY + b 5 CHGDT + b 6 PRLOSS + b 7 PRNOCF + b 8 DELAY. The inverse Mills ratio generated by this step is added to the models presented in Table 4. 10 For the audit fee ratio, χ 2 = 6.607 and the one-tailed p-value is < 0.01. For the total fee ratio, χ 2 = 2.530 and the one-tailed p-value is <0.10.

17

deviation. 11 Together with the results in Table 4, these results suggest that auditors, especially Big

N auditors, tend to report more conservatively in the post-SOX period for distressed public

companies contributing relatively more fees.

Higher audit fees and audit effort

Going concern companies likely require more audit work, and may be charged a risk

premium, both resulting in higher audit fees (DeFond et al. 2002). Therefore, as mentioned

previously, the positive association between audit fee ratios and first-time going concern reports in

2003 could be due to these factors rather than more conservative reporting. 12 Although the model

includes control variables for effort and risk, these effects may not be fully captured by the control

variables. To assess this possibility, I conduct three additional tests. Results in this section are not

tabulated.

First, if auditors perform more work or charge higher risk premiums for first-time going

concern companies in 2003, the increase in their audit fees from 2002 to 2003 should be greater

than the increase for clean-opinion companies. 13 To test this, I add the change in audit fees from

2002 to 2003, scaled by the average assets for 2002 and 2003, to models in Table 4. Results

indicate the change in audit fees from 2002 to 2003 is not significantly associated with the

likelihood of a 2003 going concern report. Further, results for AUDFEE and TOTFEE become

stronger (both p-values < 0.01, rather than 0.05).

Second, I substitute a lagged audit fee ratio for the current year audit fee ratio. The lagged

audit fee ratio is the ratio of audit fees in 2002 to the total office revenue in 2002. The rationale for

11 Economic magnitude = coefficient×p×(1-p)×one standard deviation of the variable. Where p = the probability that the dependent variable equals one.

12 Arguably, these clients are still relatively more important to the audit office, even if the greater fees arise from additional efforts and risk premiums. However, since these fees are intended to compensate for costs imposed on the auditor, they are less likely to represent profits.

13 I also compare the change in audit fees from 2002 to 2003 for first-time going concern companies to that for continuing going concern companies. The result shows there is no statistically significant difference for the change in audit fees between these two groups.

18

this substitution is that the clients’ importance to the audit offices in 2002 should be highly

correlated with their importance in 2003. However, audit fees in 2002, when the client received a

clean opinion, do not include extra work related to a going-concern client. Thus, if additional

effort specific to first-time going-concern clients is mainly responsible for the higher fees in 2003,

2002 fee ratios should not be associated with 2003 going concern reports. The result indicates the

coefficient for the lagged audit fee ratio is also positive and significant (p-value < 0.05).

Third, I include clients’ unexpected fees, after controlling for client characteristics and

audit risk factors, to models in Table 4. To measure unexpected fees, I regress the natural

logarithm of audit fees, non-audit fees and total fees on variables drawn from prior research

(Francis 1984; Craswell et al. 1995; Hay et al. 2006; Ettredge et al. 2007). These regressions are

performed for both 2001 and 2003, resulting in six separate regressions. 14 The residual from each

OLS model is unexpected fees for a fee type and fee year. UAFEE, UNAFEE, and UTOTFEE

denote unexpected audit fees, non-audit fees and total fees, respectively. Since these residuals

represent determinants of fees not captured by the standard fee models, additional audit effort and

risk premium effects may be captured here. Each of the fee models is highly significant and has

good explanatory power, with adjusted R 2 s ranging from 0.642 to 0.809. Model variables results

are consistent with prior studies, except for INVENTORY, which is significantly negative in 2003.

I add UAFEE, UNAFEE, or UTOTFEE to models in Table 4. Results indicate none of the

unexpected fee variables is significant and the results for the fee ratios remain unchanged in both

14 The OLS model is: Ln(audit fees) / Ln(non-audit fees) / Ln(total fees) = b 0 + b 1 LnAT+ b 2 ADJREV +b 3 ROA+ b 4 LEVERAGE+ b 5 CHGDT+ b 6 LIQUIDITY + b 7 PRLOSS+ b 8 PRNOCF + b 9 BIG4+ b 10 DELAY + b 11 LOSS+ b 12 OCF+ b 13 RESTATE + b 14 BUSY + b 15 RECEIVABLE + b 16 INVENTORY+ b 17 SEGMENT+ b 18 FOREIGN + b 19 SPECIALITEM, where LnAT= natural log of assets; ADJREV = sales/assets; LOSS = 1 if the firm report negative net incomes in the current year, 0 otherwise; OCF = operating cash flows/assets; RESTATE = 1 if the firm restate their earnings in the current year, 0 otherwise; BUSY = 1 if the firm’s fiscal year-end is from December to March, 0 otherwise; RECEIVABLE = accounts receivable/assets; INVENTORY = inventory/assets; SEGMENT =natural log of number of reported segments; FOREIGN =1 if the firm has foreign operations, 0 otherwise; SPECIALITEM = special items/assets. All other variables are defined in conjunction with model (1).

19

2001 and 2003. However, when controlling for unexpected fees, the change in coefficient of

AUDFEE from 2001 to 2003 becomes marginally significant (the Chow test analog χ 2 = 2.202,

one-tailed p-value < 0.10).

Overall, these results do not support the alternate possibility that results in Table 4 are due

to effects of increased audit effort on behalf of going concern clients, not otherwise captured by

model variables.

Sensitivity tests

In this section I report results of a series of sensitivity tests. Again, results are not

tabulated.

Local audit office size effects

Small audit firm offices usually have fewer publicly listed companies, and the public

companies they do have are more likely to dominate in the audit firm’s portfolio (Craswell et al.

2002). To evaluate possible effects of this, I conduct two tests. First, I interact the fee ratios with a

local office size indicator (= 1 if the total revenue of the local office is above the median for the

sample; 0 otherwise). Results indicate that neither of the interaction terms is significant in any of

the regressions, nor is the office size indicator. Second, I use only the smallest third of the local

offices (based on office revenue) in the Table 4 models. Results are similar to those reported in

Table 4. Each of these results suggests that the effect of client importance on auditors’ reporting

decisions is not significantly influenced by the size of the local offices.

Auditor switching effects

Recent studies suggest that in the post-SOX period, there is an increased frequency of

clients, particularly risky clients, shifting from Big 4 to non-Big 4 auditors (Cassell et al. 2006;

Ettredge et al. 2007). This has two possible effects on the results presented above. First, if

switching is associated with discounted fees in the early years of the new auditor-client

20

relationship (Simon and Francis 1988; Gregory and Collier 1996; Walker and Casterella 2000),

then lower fees could bias against finding fee dependence for new engagements (Craswell et al.

2002). Second, non-Big 4 auditors are more likely to have smaller local offices, and thus might be

dominated by the new, relatively large, but risky clients switching from the Big 4 in 2003. If so,

the positive association between fee ratios and going concern reports may be due to the switching

clients. To assess possible switching effects, I re-estimate all the models after removing companies

that switched auditors in the year prior to each year studied. I also delete companies from each

year studied if the reports are issued by the new auditors. Test results do not change except the

result for TOTFEE in 2003 strengthens (p-value < 0.01, rather than 0.05).

Comparison group

The comparison group for all analyses to this point is based on distressed financial

conditions. Here, I limit the observations to the third of the distressed sample with the longest

audit report lags. This analysis is based on the assumption that the delay in reporting is most likely

to be attributable to auditor-client negotiations over problematic issues that involve the exercise of

independent audit judgment (Craswell et al. 2002). Here, none of the fee ratios is significant in

either 2001 or 2003. Thus, even in cases where auditor-client negotiation may have been extensive,

greater fees are not associated with a more lenient reporting.

Power of the tests

To assess whether insignificant results for all fee ratios in 2001 and non-audit fee ratios in

2003 are due to a lack of power in the analyses, I follow Craswell et al. (2002) by adding one

standard deviation to each of the fee ratios. If the test lacks power, an increase of one standard

deviation in the explanatory variable should affect the predicted choice probability (MacKie-

Mason 1990). Results show that when fee ratios are increased by one standard deviation, the

21

proportion of correctly classified observations remains unchanged, which suggests that the

auditor’s going concern report decision is not sensitive to the increase in fee dependence.

Other specifications of client importance

Finally, I focus on different measures of client importance. First I examine auditor

reporting decisions for those public companies having the most potential influence, which is

defined as having audit fee ratios greater than the sample median. Second, I re-define AUDFEE

as the ratio of client audit fees to total local office audit fees, and NONAUDFEE as the ratio of

client non-audit fees to total local office non-audit fees. Test results for both 2001 and 2003

remain the same when using either of these alternative specifications.

6. Conclusions

This study investigates the effect of client importance on auditor independence. I measure

client importance as the proportion of total local office revenue received from a client in audit fees,

non-audit fees, or total fees. Auditor independence is measured by the auditor’s propensity to issue

a going concern opinion to a distressed client. The analysis is based on samples of financially

distressed public client firms in 2001 (pre-SOX) and 2003 (post-SOX).

Results indicate no statistically significant association between the audit fees, non-audit

fees, or total fees and going concern opinions in 2001. This is consistent with findings in prior

studies using national-level firm analysis (DeFond et al. 2002). However, in 2003 results show a

positive association between audit (and total) fees and going concern opinions. Non-audit fees

continue to be unassociated with going concern opinions. These results are generally robust to a

variety of alternative definitions and sensitivity tests. Additional analysis indicates that the

association between distressed companies contributing more audit fees and receiving going

concern reports is more pronounced for Big N clients.

22

The findings in this study do not support concerns that distressed companies contributing

relatively more public-client fees receive more lenient treatment from their auditors. Rather, in

2003, companies contributing more fees are more likely to receive going concern reports. This is

consistent with the view that auditors reporting more conservatively for larger clients to protect

their reputations and to avoid litigation costs in the sensitive post-SOX period. However, the

association is also consistent with firms performing more audit work or charging a higher risk

premium for troubled clients in the latter period. A series of additional tests does not find

evidence supporting this alternative explanation, but it cannot be ruled out definitively. Future

researchers may be able to obtain information about hours charged to such engagements to better

separate these effects. Another limitation of this study is the limited time period, including only

one year pre- and one year post-SOX. Analysis of the pre-SOX era is limited by fee data

availability. But the immediate post-SOX year studied here may not prove representative of an

equilibrium of the post-SOX audit market. This is another avenue for future research.

23

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28

Table 1 Summary of Prior Studies on Fee Dependence and Auditor Independence

 

Country

Sample

Level of

Proxy for impairment of auditor independence

Audit

Non-audit

Total

Client

 

Year

analysis

Fees

Fees

Fees

Sales

Craswell et al. (2002)

Australia

1994, 1996

National

Qualified audit reports Qualified audit reports

ns

ns

na

na

 

Office

ns

na

na

na

Ruddock et al. (2006)

Australia

1993-2000

National

Earnings conservatism

na

ns

na

na

Lennox (1999)

UK

1988-1994

National

Qualified audit reports

na

+

na

na

Firth (2002)

UK

1996

National

Qualified audit reports

ns

-

-

na

Ferguson et al. (2004)

UK

1996-1998

National

Absolute discretionary accruals Restatements Absolute discretionary accruals Restatements

na

+

na

na

 

na

+

na

na

 

Office

na

+

na

na

 

na

+

na

na

Basioudis et al. (2006)

UK

2003

National

Going concern reports

+

-

na

na

Reynolds & Francis (2001)

US

1996

Office

Absolute total accruals Absolute discretionary accruals Going concern reports

na

na

na

-

 

na

na

na

-

na

na

na

+

Frankel et al. (2002)

US

2001

National

Absolute discretionary accruals Income-increasing discretionary accruals Income-decreasing discretionary accruals Just meet analysts' expectations

-

+

ns

na

 

-

+

+

na

+

-

ns

na

-

+

ns

na

DeFond et al. (2002)

US

2001

National

Going concern reports

ns

ns

ns

na

Ashbaugh et al. (2003)

US

2000

National

Absolute discretionary accruals Income-increasing discretionary accruals Income-decreasing discretionary accruals Just meet analysts' expectations

ns

+

ns

na

 

ns

ns

ns

na

ns

-

ns

na

ns

ns

ns

na

29

(The table is continued on the next page.)

Table 1 (Continued)

 

Country

Sample

Level of

Proxy for impairment of auditor independence

Audit

Non-audit

Total

Client

 

Year

analysis

Fees

Fees

Fees

Sales

Chung & Kallapur (2003)

US

2001

National

Absolute discretionary accruals Absolute discretionary accruals

na

ns

ns

na

 

Office

na

ns

ns

na

Geiger & Rama (2003)

US

2001

National

Going concern reports

+

ns

na

na

Raghunandan et al. (2003)

US

2001

National

Restatements

na

ns

ns

na

 

1995-

Kinney et al. (2004)

US

2000

National

Restatements

+

ns

na

na

Larcker & Richardson

2000-

(2004)

US

2001

National

Directional discretionary accurals Absolute discretionary accruals Income-increasing discretionary accruals Income-decreasing discretionary accruals

na

ns

ns

na

 

na

-

-

na

na

-

-

na

na

+

+

na

Reynolds et al. (2004)

US

2001

National

Absolute discretionary accruals

na

ns

ns

na

Gaver and Paterson

 

(2007)

US

1993

Office

Under-reserve for financially weak insurers

-

na

na

-

Abbreviations for fees and sales coefficients:

na = not applicable (not tested). ns = tested but not significant.

+ = positive, significant coefficient.

- = negative, significant coefficient.

30

Table 2 Descriptive Statistics for Financial Distressed Companies

2 Descriptive Statistics for Financial Distressed Companies Panel A: Descriptive Statistics for 2001 Full Sample (

Panel A: Descriptive Statistics for 2001

Full Sample ( n = 1,681)

GC Sample ( n = 126)

NO GC Sample ( n = 1,555)

Variables

Mean

Median

Std. Dev.

Mean

Median

Mean

Median

t-statistic

Z-statistic

AUDFEE

0.052

0.009

0.121

0.068

0.011

0.051

0.009

1.531

1.154

NONAUDFEE

0.043

0.007

0.099

0.041

0.004

0.043

0.007

-0.254

-2.196

TOTALFEE

0.095

0.018

0.193

0.109

0.019

0.094

0.018

0.834

0.082

SALES

18.054

18.065

2.363

16.564

16.481

18.174

18.152

-7.475

*

-7.407

*

ROA

-0.383

-0.128

0.816

-1.007

-0.653

-0.333

-0.113

-9.142 *

-9.921 *

LEVERAGE

0.502

0.442

0.388

0.788

0.694

0.478

0.430

8.813 *

6.451 *

LIQUIDITY

3.496

2.105

4.014

1.323

0.745

3.672

2.231

-6.392 *

-10.940 *

CHGDT

0.012

0.000

0.158

-0.008

0.000

0.013

0.000

-1.481

-2.395

PRLOSS

0.601

1.000

0.490

0.794

1.000

0.585

1.000

4.622

*

4.594 *

PRNOCF

0.520

1.000

0.499

0.754

1.000

0.501

1.000

5.513 *

5.466 *

BIG N

0.860

1.000

0.347

0.778

1.000

0.866

1.000

-2.754 *

-2.748 *

DELAY

55.207

51.000

25.619

75.111

80.500

53.594

50.000

9.295 *

8.597 *

NEWDEBT

0.405

0.000

0.491

0.365

0.000

0.408

0.000

-0.938

-0.938

Panel B: Descriptive Statistics for 2003

 
 

Full Sample ( n = 1,780)

GC Sample ( n = 108)

NO GC Sample ( n = 1,672)

 

Variables

Mean

Median

Std. Dev.

Mean

Median

Mean

Median

t-statistic

Z-statistic

AUDFEE

0.075

0.015

0.162

0.160

0.043

0.069

0.014

5.678 *

4.381 *

NONAUDFEE

0.022

0.004

0.053

0.024

0.003

0.022

0.004

0.432

-0.875

TOTALFEE

0.097

0.021

0.194

0.184

0.054

0.092

0.020

4.846 *

3.948 *

SALES

17.675

17.765

2.526

15.980

16.044

17.784

17.844

-7.299 *

-6.364

*

ROA

-0.307

-0.108

0.949

-1.489

-0.394

-0.231

-0.099

-14.078 *

-8.743 *

LEVERAGE

0.656

0.517

0.984

1.744

0.862

0.585

0.501

12.349 *

8.184 *

LIQUIDITY

3.171

1.918

3.537

1.066

0.480

3.307

2.009

-6.452 *

-11.116 *

CHGDT

-0.003

0.000

0.814

-0.091

0.000

0.003

0.000

-1.165

-2.181

PRLOSS

0.733

1.000

0.442

0.852

1.000

0.725

1.000

2.883

*

2.877 *

PRNOCF

0.509

1.000

0.500

0.685

1.000

0.498

0.000

3.792 *

3.778 *

BIG N

0.712

1.000

0.453

0.435

0.000

0.730

1.000

-6.643 *

-6.564 *

DELAY

65.572

63.000

38.005

85.000

80.500

64.318

61.000

5.527 *

7.305 *

NEWDEBT

0.376

0.000

0.485

0.213

0.000

0.387

0.000

-3.629 *

-3.616 *

Notes:

Fee information is obtained from Audit Analytics and financial information is obtained from Compustat. The sample is restricted to financially distressed firms, defined as those that report either negative net income or negative operating cash flows.

* Significant at the 0.01 level (two-tailed).

Significant at the 0.05 level (two-tailed).

Variables definition:

GC

= going concern company.

NO GC

= clean opinion company.

AUDFEE

= client audit fees divided by the total revenue of the auditor local office that issues the audit report.

NONAUDFEE = client non-audit fees divided by the total revenue of the auditor local office that issues the audit report.

TOTALFEE

= client total fees divided by the total revenue of the auditor local office that issues the audit report.

SALES

= natural logarithms of client’s total revenue at the end of the year.

ROA

= net income divided by total assets at the end of the year.

LEVERAGE

= total liabilities divided by total assets at the end of the year.

LIQUIDITY

=total current assets divided by total current liabilities at the end of the year.

CHGDT

= the change of long-term debt divided by assets from year 2000 (2002) to 2001 (2003).

PRLOSS

= an indicator variable equal to 1 when the firm reported negative net income in year 2000 (2002); 0 otherwise.

PRNOCF

= an indicator variable equal to 1 when the firm reported negative operating cash flows in year 2000 (2002); 0 otherwise.

BIG N

= an indicator variable equal to 1 when the auditor is Big 4 (5); 0 otherwise.

DELAY

= number of days between fiscal year-end and the auditor’s sign date.

NEWDEBT

= an indicator variable equal to 1 when the firm issues new debt in the subsequent year; 0 otherwise.

32

Table 3 Pearson Correlation Tables

Panel A: Correlation Table for Year 2001

Variables

AUDFEE

NONAUDFEE

TOTALFEE

SALES

ROA

LEVERAGE

LIQUIDITY

CHGDT

PRLOSS

PRNOCF

BIG N

DELAY

NEWDEBT

GC

0.04

-0.01

0.02

-0.18

-0.22

0.21

-0.15

-0.03

0.11

0.13

-0.07

0.22

-0.02

AUDFEE

0.52

0.90

-0.01

0.03

0.11

-0.08

0.01

-0.05

-0.07

-0.53

0.10

0.02

NONAUDFEE

0.84

0.25

0.08

0.10

-0.10

0.01

-0.12

-0.14

-0.20

0.01

0.08

TOTALFEE

0.12

0.06

0.12

-0.10

0.01

-0.09

-0.12

-0.44

0.07

0.06

SALES

0.27

0.22

-0.32

0.00

-0.34

-0.43

0.25

-0.12

0.24

ROA

-0.18

0.07

-0.15

-0.26

-0.25

0.08

-0.09

0.08

LEVERAGE

-0.46

0.19

0.00

-0.07

-0.13

0.26

0.27

LIQUIDITY

-0.02

0.09

0.17

0.08

-0.22

-0.21

CHGDT

0.05

0.04

-0.04

0.00

0.10

PRLOSS

0.47

-0.01

0.10

-0.10

PRNOCF

-0.06

0.08

-0.15

BIG N

-0.13

-0.02

DELAY

0.10

Panel B: Correlation Table for Year 2003

 

Variables

AUDFEE

NONAUDFEE

TOTALFEE

SALES

ROA

LEVERAGE

LIQUIDITY

CHGDT

PRLOSS

PRNOCF

BIG N

DELAY

NEWDEBT

GC

0.13

0.01

0.11

-0.17

-0.32

0.28

-0.15

-0.03

0.07

0.09

-0.16

0.13

-0.09

AUDFEE

0.49

0.97

-0.11

-0.03

0.09

-0.10

-0.11

-0.09

-0.03

-0.45

0.08

0.00

NONAUDFEE

0.68

0.10

0.05

0.01

-0.05

0.00

-0.07

-0.11

-0.20

0.03

0.09

TOTALFEE

-0.07

-0.01

0.08

-0.10

-0.09

-0.09

-0.06

-0.43

0.08

0.02

SALES

0.36

-0.04

-0.29

0.08

-0.17

-0.46

0.42

-0.02

0.24

ROA

-0.57

0.07

0.04

-0.17

-0.23

0.14

-0.07

0.11

LEVERAGE

-0.26

0.21

0.06

0.03

-0.13

0.14

0.06

LIQUIDITY

0.01

0.08

0.16

0.11

-0.20

-0.15

CHGDT

-0.01

-0.02

0.03

0.00

0.04

PRLOSS

0.38

0.05

0.00

-0.06

PRNOCF

-0.08

-0.02

-0.13

BIG N

-0.09

0.08

DELAY

0.04

Notes:

All correlations with absolute value of 0.04 and above are statistically significant at the 0.10 level.

33

Table 4 Logistic Regressions for the Relations between Client Importance and Going Concern Opinions in 2001 and 2003

Panel A: Year =2001

Panel B: Year = 2003

 

Expected

Sign

Model 1a Coefficient (Wald χ 2 )

Model 1b Coefficient (Wald χ 2 )

Model 1a Coefficient (Wald χ 2 )

Model 1b Coefficient (Wald χ 2 )

Variables

 

1.774

1.776

0.879

0.933

Intercept

(3.061)

(3.121)

(0.644)

 

(0.736)

 

0.766

1.326

AUDFEE

?

(0.532)

(5.274)

 
 

0.730

0.186

NONAUDFEE

?

(0.317)

(0.007)

 
 

0.750

1.166

TOTALFEE

?

(1.549)

(6.248)

 
 

-0.346

-0.346

-0.198

-0.201

SALES

-

(39.154) *

(39.345) *

(10.566)

*

(11.017)

*

 

-0.157

-0.157

-0.180

-0.179

ROA

-

(2.363)

(2.363)

(2.836)

 

(2.816)

 
 

0.616

0.616

0.096

0.096

LEVERAGE

+

(6.007)

(6.009)

(0.879)

 

(0.875)

 
 

-0.514

-0.514

-0.678

-0.680

LIQUIDITY

-

(33.568)

*

(33.578)

*

(32.205) *

 

(32.397) *

 

-1.279

-1.279

0.051

0.048

CHGDT

?

(7.994) *

(8.022) *

(0.419)

 

(0.376)

 
 

0.233

0.233

0.518

0.519

PRLOSS

+

(0.706)

(0.708)

(2.742)

 

(2.754)

 
 

0.845

0.845

0.082

0.083

PRNOCF

+

(9.955) *

(9.991) *

(0.092)

 

(0.094)

 
 

0.672

0.670

0.152

0.146

BIG N

+

(3.937)

(4.105)

(0.266)

 

(0.248)

 
 

0.018

0.018

0.005

0.005

DELAY

+

(17.891) *

(17.904) *

(5.247)

(5.259)

 

-0.189

-0.189

-0.745

-0.761

NEWDEBT

-

(0.699)

(0.702)

(7.835) *

 

(8.285) *

 

N = Chi-Square Pseudo R 2

1681

1681

1780

1780

248.138 *

248.138 *

208.108 *

 

207.888 *

 

0.332

0.332

0.300

0.300

Notes:

Fee information is obtained from Audit Analytics and financial information is obtained from Compustat.

The sample is restricted to financially distressed firms, defined as those that report either negative net income or negative operating cash flows.

* Significant at the 0.01 level (two-tailed).

Significant at the 0.05 level (two-tailed).

Significant at the 0.10 level (two-tailed).

34

Table 5 Logistic Regressions for the Relations between Client Importance and Going Concern Opinions in 2001 and 2003 for Big N and Non-Big N Auditors

Panel A: Year = 2001

Clients of Big N Auditors

Clients of non-Big N Auditors

 

Expected

Sign

Model 1a Coefficient (Wald χ 2 )

Model 1b Coefficient (Wald χ 2 )

Model 1a Coefficient (Wald χ 2 )

Model 1b Coefficient (Wald χ 2 )

Variables

 

2.119

1.890

4.228

4.015

Intercept

(3.312)

 

(2.683)

 

(1.911)

(1.773)

-3.131

1.915

AUDFEE

?

(1.251)

 

(2.292)

 

2.811

-0.388

NONAUDFEE

?

(1.434)

 

(0.054)

 

-0.056

0.967

TOTALFEE

?

(0.003)

 

(1.364)

 

-0.354

-0.340

-0.411

-0.388

SALES

-

(34.224)

*

(32.616)

*

(4.875)

(4.562)

 

-0.270

-0.269

0.069

0.048

ROA

-

(6.088)

(6.066)

(0.116)

(0.057)

 

0.860

0.841

0.096

0.111

LEVERAGE

+

(7.643) *

 

(7.367) *

 

(0.048)

(0.063)

 

-0.438

-0.425

-1.356

-1.319

LIQUIDITY

-

(24.245)

*

(22.722)

*

(11.777) *

(11.342) *

 

-1.483

-1.465

0.484

0.300

CHGDT

?

(9.804) *

 

(9.579) *

 

(0.123)

(0.046)

 

0.368

0.349

-0.281

-0.291

PRLOSS

+

(1.303)

 

(1.179)

 

(0.196)

(0.213)

 

0.677

0.661

1.668

1.508

PRNOCF

+

(5.148)

 

(4.938)

 

(5.503)

(4.927)

 

0.020

0.020

0.014

0.014

DELAY

+

(18.168) *

 

(17.567) *

 

(2.299)

(2.205)

 

-0.205

-0.202

-0.505