Non-audit service fees and stock price crash risk

Abstract

The paper investigates the relationship between non-audit service fees received by the firm's incumbent auditor and the client firm's stock price crash risk. I partition the sample into three subsamples based on the ratio of non-audit service fees to total fees (NASFEERATIO) and then regress NASFEERATIO on three proxies for stock price crash risk. I find that for firms with medium level of NAS fee ratio, the coefficients of NASFEERATIO are significantly negative. However, for firms with a high NAS fee ratio, the coefficients of NAS fee ratio are significantly positive. Further analysis shows that for firms with a high NAS fee ratio, the positive coefficients of NAS fee ratio are only significant for firms with lower institutional ownership and lower quality of corporate governance. Besides, for firms with a medium level of NAS fee ratio, the coefficients of NAS fee ratio are only significantly negative for firms with lower institutional ownership and whose auditors provide service to more clients. The results suggest that the effect of NAS fees on stock price crash risk depends on the trade-off of knowledge spillover effect and economic bond effect. For firms with medium level of NAS fees, knowledge spillover effect dominates and increased knowledge help prevent managers from withholding bad news and thus reduces future stock price crashes, while for firms with high level of NAS fees, economic bond effect dominates and auditors compromise to the managers' pressure and thus have less incentive to prevent the bad news hoarding behavior of managers, which increases stock price crash risk. The findings also suggest that higher percentage of institutional ownership and high quality of corporate governance can mitigate the economic bond effect for the sample with high level of NAS fee ratio. Besides, a higher percentage of institutional ownership substitutes for the knowledge spillover effect and auditor experience can enhance the knowledge spillover effect for the sample with a medium level of NAS fee ratio. The results contribute to the literature on non-audit service and demonstrate the non-linear relationship between non-audit service fees ratio and stock price crash risk. The findings of the paper provide implications for investors and regulators and can help investors to better understand the economic consequences of the joint provision of audit service and non-audit service.