Nonaudit services and earnings management in the Pre-SOX and Post-SOX eras

Abstract

Concerns about the impact of auditor-provided nonaudit services (NAS) on auditor independence arise because of (1) auditors' economic dependence on their clients, and (2) some specific types of NAS which the Securities and Exchange Commission (SEC) argues can harm auditor objectivity. The SEC's prohibition in 2003 of specific kinds of NAS led to a significant decline in NAS between 2000-2001 and 2004- 2005. We argue that this decline in observed NAS fees can be used to identify firms that had a greater likelihood of impaired auditor independence in the pre-SOX period. Using discretionary accruals to proxy for earnings management, we find a positive association between discretionary accruals in the pre-SOX era and the subsequent reduction in NAS, but this was confined to income-decreasing accruals. Further, the association between downward earnings management and the decline in NAS was reduced in the post-SOX era.