Journal of Accounting, Auditing &

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Audit Opinion and Disclosure of Audit Fees
Kam-Wah Lai
Journal of Accounting, Auditing & Finance 2009 24: 91
DOI: 10.1177/0148558X0902400106
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Audit Opinion and Disclosure
of Audit Fees
KAM-WAH
LAI*

Dye (1991) suggests that when audit fees are disclosed, auditor independence will be improved because there are no quasi-rents to influence
audit opinion and the public could assess the independence of the auditors. According to DeAngelo (1981a), however, disclosure of audit fees
is irrelevant to the issuance of audit opinion because transaction costs,
which give rise to quasi-rents, could not he affected by disclosure of
audit fees. This paper examines this controversy by investigating the issuance of a going concern modified audit opinion before and after the disclosure requirement c$, the Securities and Exchange Commission (2000).
The results show that financial statements issued after the disclosure
requirement are more likely to be associated with a going concern opinion than those issued before the disclosure requirement. These results
are robust to various .sensitivity tests, including the control for the effect
of economic factors, auditor reporting conservatism, and auditor reporting accuracy. In addition, it is found that firms before (after) the disclosure requirement are more (less) likely to receive a going concern
opinion if audit fees were (were not) disclosed. Hence, this paper provides evidence to suggest that disclosure of audit fees is associated with
enhanced auditor independence, and thus supports Dye’s (1991) theory.

Keywords: Dischure of audit jees, going concern opinion, auditor independence,
quasi-rents

1. Introduction
As a response to the concern over possible loss of auditor independence arising from the provision of nonaudit services by incumbent auditors, the Securities
and Exchange Commission (SEC) requires companies to disclose nonaudit fees and
audit fees in their proxy statements filed on or after February 5, 2001 (SEC [2000]).
Subsequent empirical studies (e.g., Frankel, Johnson, & Nelson [2002]; Ashbaugh,
*School of Accounting and Finance, the Hong Kong Polytechnic University.
I acknowledge valuable comments from an anonymous reviewer, and research assistance from
Y. S. Chan and Samantha Tse.
Data are publicly available from sources identified in the paper.

91
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2. Jaggi. because disclosure could not affect transaction costs that give rise to quasi-rents. The research method is then discussed. & Krishnan [forthcoming]) have focussed on auditor independence and nonaudit services. auditor independence will be enhanced with the disclosure of audit fees. DeAngelo (198 la) suggests that quasi-rents will induce low-balling (pricing initial audit fees below the cost of performing the audit) but that it will not affect the audit opinion as such discounts are sunk costs. The next section of the paper develops the hypothesis.sagepub. this paper contributes to the literature by providing evidence that suggests that disclosure of audit fees is relevant. Craswell & Francis [1999]) examine discounts in initial audit fees when audit fees are publicly disclosed.. Her suggestion would hold even when audit fees are disclosed. The last two sections discuss the results. Although some studies (e.com at Scientific library of Moscow State University on November 13. because the absence of quasi-rents minimizes the incentives for the auditor to distort the report he is willing to attest to. However. & Subramanyam [2002]. Gul. Downloaded from jaf. we would expect future quasi-rents associated with equilibrium prices to be zero. Dye (1991.” Thus. The examination of such a relationship is essential from an important theoretical perspective. Hence. & Mayhew [2003]. DeFond. a useful and direct measure of auditor independence as suggested by DeAngelo (1981b). an important and controversial relationship between audit opinion and the disclosure of audit fees has not been examined in prior studies. and present conclusions. I am not aware of a study that examines the relationship between audit opinion and the disclosure of audit fees. there is a clear controversy in the literature. Hypothesis DeAngelo (1981b) suggests that an auditor is independent if he reports detected material misstatements in audited financial statements. Raghunandan.g. it is found that firms before (after) the disclosure requirement are more (less) likely to receive a going concern opinion if audit fees were (were not) disclosed.92 JOURNAL OF ACCOUNTING. DeAngelo (198 la) further contends that quasi-rents of incumbency will induce low-balling. However. and auditor reporting accuracy. 2013 . This result is robust to the control for the possible effect of economic downturn. Quasi-rents become zero because auditors who receive no quasi-rents will incur lower legal costs and pass some of those savings on to their clients. auditor reporting conservatism. AUDITING & FINANCE LaFond. the results are consistent with Dye’s (1991) suggestion that disclosure of audit fees will improve auditor independence. 355) contends that “[ilf the prices of audit services are public. Hence. The results of this paper show that financial statements issued after the disclosure requirement (as defined in Section 3) are more likely to be associated with the issuance of a going concern modified audit opinion. Chung & Kallapur [2003]. This paper fills this void in the literature by investigating whether following the disclosure requirement auditors are more likely to issue modified audit opinion. Thus. followed by a description of the sample selection. In addition. including sensitivity analyses and limitations.

356) argues that “[wlhen outsiders are risk-averse. It does not.93 AUDIT OPINION AND DISCLOSURE OF AUDIT FEES but auditor independence. will not be affected. this uncertainty in their interpretation of a report will cause them to modify their interaction with the client. will not be affected by low-balling. typically to the client’s detriment. Dye suggests that this is not a problem. 2013 . audit costs. the auditor has an incentive to ensure that his or her audit is profitable in each year over the tenure. that is. Dye (1991). auditors will become more independent. Thus. The extant theorv. Because initial start-up costs are sunk costs. however. Quasi-rents arise from transaction costs of the auditors and their clients. Audit firms incur higher start-up costs of initial audit but can economize such costs in subsequent audits and achieve cost savings. audit firms could raise audit fees in subsequent audits and earn quasi-rents. however. Because of competitive pressure. the passing of some of the savings to the client is also likely to be over the tenure.com at Scientific library of Moscow State University on November 13. disclosure of audit fees and quasi-rents are unrelated because disclosure of audit fees could not affect transaction costs. Auditees incur costs of switching auditors in the form of search costs and the cost of introducing its operation to the new auditor. the auditors’ reporting decision. Hence. auditors will incur lower legal costs and pass on some of the savings to the clients. I - Downloaded from jaf. as there are no quasi-rents in future audits to recoup any initial loss. disclosure of audit fees is important because. However.’ Without disclosure.’ The disclosure of audit fees is not equivalent to the disclosure of quasi-rents. Specifically. audit fees over the tenure are likely to be lower than the same without the passing. as such. Both of these effects favor auditor/client relationships in which quasi-rents 1. outsiders could assess the independence of the auditors and interpret the firms’ financial reports more effectively. auditor independence would not be affected by the disclosure of audit fees. auditors will discount initial audit fees to obtain incumbency and earn quasi-rents. as proxied by audit opinion. on the other hand.561). with disclosure. suggests that disclosure would make a difference. With disclosure. Hence. however. Under DeAngelo’s (1981a) argument. zero quasi-rents are in the interest of both the clients and the auditors. the lower audit fees in the first year do not likely result in lowballing. 3. clients could increase “the auditor’s quasi-rents from zero to some small positive amount” and get “the auditor to attest to slightly more favourable reports” (Dye 11991. the public could not observe quasi-rents (and hence interpret audit report) with complete certainty. and the opportunity costs of being fired by the client. the same is not tested in this paper. suggests that auditor indeoendence will be higher when audit fees are disclosed compared with the case in which the fees are not disclosed. However. This could be done because outsiders could not ascertain whether a favorable audit opinion is truly the result of the firms’ favorable conditions or the result of the auditors’ compromised independence. Because of the lack of theoretical framework in this aspect. Dye (1991.sagepub. because auditors will be perceived to be most independent when they receive no quasi-rents and. because quasi-rents include audit fees. With disclosure. Hence. Hence. Hence. Consequently. The cost savings will accrue to the auditor over his tenure. more important. 2. deal with how auditor independence will be assessed by the public in a period of fees disclosure. the audit opinion. there are no quasi-rents and.

The zero quasi-rents condition will eliminate the auditors’ incentive to distort the audit report and hence reduce the auditors’ expected liability and the fee which they must be paid. costs of performing these engagements. Dye (1991.com at Scientific library of Moscow State University on November 13. If the auditor has the larger bargaining power. the incumbent perform all subsequent audits at the present value of . in doing so. 3. . Thus. Thus. 5. Another effect is auditors’ liability cost. Downloaded from jaf. 348-349) also suggests that If. 355) contends that “[ilf the prices of audit services are public. . . then the auditor would ignore low-balling prior to disclosure as he is a price-taker. client’s increased bargaining power following disclosure of audit fees is a supporting (but not a competing or an alternative) explanation of (to) Dye’s (1991) theory. note 4) suggest that “[ilf the bargaining power rests entirely with the client. Thus. . Magee and Tseng (1990. endangers his or her independence and. and thus jeopardizes his or her independence. . Dye (1991) assumes that the client has equal power.” Dye (1991. But if the client has the larger bargaining power..94 JOURNAL OF ACCOUNTING. then the value of incumbency will be zero and there will be no low-balling and no incentive to compromise independence to retain the client. . . it would reinforce Dye’s (1991) arguments. he or she does not receive (in equilibrium) quasi-rents from the client and hence could maintain independence.” The differences in DeAngelo’s (1981a) and Dye’s (1991) theories lie in the differences in the assumption of the relative bargaining power of the client versus the auditor in setting audit fees and hence determining quasi-rents. when audit fees are disclosed. The consequence is that the auditor will continue to lose independence after disclosure. we were to posit that the client possessed all bargaining power. whether auditor independence. as proxied by audit opinion. 318. 4.. under Dye’s (1991) argument. he would propose that. . This line of reasoning is supported by DeAngelo (1981b). the auditor receives quasi-rents from the client when audit fees are not disclosed and. then quasi-rents will not be zero in equilibrium when audit fees are disclosed.sagepub. eliminates l~w-balling!~ Hence. . H I : Audit opinion is not more or less likely to be modified when audit fees are disclosed than when they are not. we would expect future quasi-rents associated with equilibrium prices to be zero. as he or she did before the disclosure of audit fees. this change in the assumed relative bargaining power . In other words. While DeAngelo (1981) assumes that the auditor has the larger bargaining power. the auditor will not ignore low-balling before disclosure of audit fees and continue to recoup quasi-rents after the disclosure. instead. will be improved following disclosure of audit fees is an empirical issue and the following null hypothesis is formulated for testing. Note that if disclosure of audit fees increases the client’s bargaining power in setting audit fees. AUDITING & FINANCE are Thus. One way that risk-averse outsiders could cause detriment to clients is that they could lower the price offered for the securities of the clients if they suspect that the incumbent auditors are not perfectly independent. 2013 .

As PMODIFY is added only as a control.* The 6. DeFond et al. If. the subject matter of audit modification is not restricted to a going concern to save searching efforts for audit reports.Z score BIG5 = 1 if the firm’s auditor in year f is a Big 5 auditor. MODIFY = aa t alLTA f aZPROFIT+ a3CHBETA f @LOSS+ arPMODIFY t ahCFLOW t a7ADJRETt asZS + agBIG5 t al&SALE t a1 [AFTER (1) where MODIFY = 1 if the firm receives a going concern modified audit opinion in year t.natural logarithm of total assets PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat p in year t minus p in year t .. In Dye’s (1991) theory.7 expressed in percentage zs . 2013 .com at Scientific library of Moscow State University on November 13. Research Method and Sample To test whether auditors are more or less likely to issue modified audit opinion after the disclosure requirement of audit fees (and nonaudit fees) mandated by the SEC’s (2000) independence rule. 2002. 8. despite the possibility that it biases in favor of finding results of improved independence as future quasi-rents of those clients are likely to be lower than clients with clean opinion. such a bias will be against (instead of in favor 00 finding results that support Dye’s (1991) theory.2000 The dependent variable is MODIFY that takes the value of 1 if the firm receives a going concern modified audit opinion in year t . 2001. AFTER = 1 if the observation relates to financial year-end after March 1. or 0 otherwise. and annual earnings announcement made before June 30. Return of the market is obtained from the Centre of Research on Security Prices and proxied by value-weighted return of firms on the American Stock Exchange.1 ELOSS = I if the firm has a reported loss in year t or year t . Downloaded from jaf. to total sales of all clients of auditor. in the predisclosure period. A going concern opinion is frequently used as a more stringent test of auditor independence because of the severity of the subject matter (e. the following audit opinion model is run by logistic regression.g. and annual earnings announcement made before June 30. the use of a going concern opinion makes finding higher auditor independence easier. 7.sagepub. then it is more difficult to find even higher independence after the disclosure. quasi-rents are positive (zero) without (with) disclosure of audit fees. and from the National Association of Securities Dealers Automated Quotation. 1999.1. However. or 0 otherwise LTA . [2002]). or 0 otherwise PMODIFY = 1 if the firm receives a modified audit opinion in year t . or 0 otherwise‘ CFLOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market.1. or 0 otherwise PSALE = ratio of sales of clientj of auditorn. and there is improved auditor independence after rather than before the disclosure. the New York Stock Exchange.AUDIT OPINION AND DISCLOSURE OF AUDIT FEES 95 3. or 0 if the observation relates to financial year-end after June 1.

none of the interaction terms is individually significant.g. (1). a2 is expected to be negative. 2002. 2001 . Thus. 2000 (Accounting Today [2000]). A logistic regression is run on eq. Monroe & Teh [1993]) show that there is some persistence in the auditors’ reporting decision. The result of AFTER reported in column 3 of Table 4 remains substantially unchanged in those analyses. AUDITING & FINANCE variable for testing the hypothesis is AFTER that takes the value of 1 if the observations are classified as after the disclosure requirement. A concern is that AFTER may be correlated with factors that change over time. a5 is expected to be positive. 2002. is expected to be positive. a lower Z 9.sagepub. Observations are classified as before the disclosure requirement if the financial year-end is after June 1. Because earnings announcement may not be concurrent with the filing of a proxy statement. (1) holds equally for the disclosure and predisclosure periods. 2000. 2001. In addition. Therefore. Observations are classified as after the disclosure requirement if the financial year-end is after March 1. as firms only file the required proxy statement after the year-end. As less profitable firms (PROFIT) have higher financial risk (Chen & Church [1992]). 2013 . Downloaded from jaf. Another concern is that auditors’ reporting decision process may have changed over time. may be misclassified as observations after the disclosure requirement if proxy statements are filed before that date. These factors are controlled for in the sensitivity analyses. observations with annual earnings announcement made shortly after February 5. such factors possibly include economic factors that affect firms’ financial conditions or factors that affect auditors’ reporting conservatism. The cutoff date is set at June 30. In other words. Other variables are added as controls in eq. (1) holds equally for both the predisclosure and disclosure periods. the predisclosure period is not confounded by potential public pressure concerning auditor independence since the preliminary rule on disclosure to the final rule and the disclosure period is not confounded by the potential effect of the Sarbanes-Oxley Act. then the interaction terms should be simultaneously equal to zero. and the annual earnings announcement is made before June 30.. . 1999. Because firms with a higher likelihood of bankruptcy (in this paper. 2002. auditors may place more (or less) weight on some variables in eq. or 0 otherwise. because the Sarbanes-Oxley Act was passed into law on July 30. because the preliminary rule on auditor independence was made on July 27. (1) with the addition of the interaction terms and the null hypothesis that all the interaction terms are simultaneously equal to zero are not rejected ( p = 0. The cutoff date is set at June 30.96 JOURNAL OF ACCOUNTING. Prior studies (e. Thus. For the issuance of a going concern opinion. the evidence suggests that eq. 2000. (1) in the disclosure period but not in the predisclosure period or vice versa. observations are classified as after the disclosure requirement if the financial year-end is after March 1 . To investigate this issue.com at Scientific library of Moscow State University on November 13. 2001. If auditor independence is improved when audit fees are disclosed. (1) and the interaction terms are added. If eq. To have a clear cutoff and unambiguous classification.907). a .9 and the annual earnings announcement is made before June 30. AFTER is interacted with each of the independent variables in eq.

Mutchler.com at Scientific library of Moscow State University on November 13. McKeown. Observations were deleted if the names of the auditors 10. Hence. audit reports were searched from the EDGAR and Disclosure databases for observations with additional paragraphs (coded as 4 by Compustat) to identify a going concern modification." Following prior studies (e. The variable PSALE is added to control for the importance of the clients to the auditors. Downloaded from jaf. Hopwood. In terms of the two-digit Standard Industry Code (SIC). & McKeown [1997]). & McKeown [1997]. Francis and Wilson (1988) suggest that clients' sale could be used as a proxy for client-specific quasi-rents. Audit reports were searched from the EDGAR and Disclosure databases for the names of auditors classified as others by Compustat. Results and Discussion To test the hypothesis. In addition. & Leftwich [1987]). the sample is further restricted to financially distressed firms. & Geiger & Raghunandan [2002]). To compute the variable PSALE. (2) a loss from operations in any of the prior three years. Raghunandan. & Mutchler [ 19941. Hopwood. If the client is more important to the auditor. PSALE measures the importance of the clients in terms of quasi-rents to the auditors. Hence. Because regulated firms and financial firms may have operating and financial characteristics that are not similar to other firms. a9 is expected to be positive. which are those with (1) negative working capital in the last year. firms with a SIC between 40 and 49 or 60 and 69 are excluded from the sample. and (2) data on sales of clients of the auditors from Who Audits America. as Big 5 auditors (BIC5) are more likely to offer higher-quality audits because of their larger size (DeAngelo [1981b]).g. Holthousen.AUDIT OPINION AND DISCLOSURE OF AUDIT FEES 97 score) are more likely to receive a going concern modification (Mutchler. PSALE is the ratio of sales of a client of an auditor to total sales of all clients of that auditor. it may receive a clean opinion more easily from the auditor. data on total sales of clients of auditors were collected from Who Audits America. Hopwood.. (3) negative retained earnings in any of the prior three years. the necessary data for eq. Lastly.sagepub. Then. 2013 . or (4) a bottom-line loss in any of the prior three years. Similar to Stice (1991). a6 is expected to be negative as firms with lower cash flow (CFLOW) are more likely to fail (DeFond. (1) were collected from Compustat. they are deleted from the sample. The sample consists of observations available from Compustat along with (1) audit reports available from the EDGAR and Disclosure databases. Firm size (LTA) is added as a control for possible unknown omitted factors and no expectations are formulated for a l . a3 is expected to be positive and a7 is expected to be negative because firms with larger change in systematic risk (CHBETA) or lower stock return (ADJRET) are more risky (Dopuch. observations with additional paragraphs other than a going concern were deleted. 4. ax is expected to be negative. Similarly. & Subramanyam [2002]). a l o is expected to be negative. After deleting observations with missing value.

In Panel A. (1). the results are not driven by the firm’s financial condition. Hence.642 firm-year observations. As discussed later in the paper. The correlation matrix of the variables of the sample is shown in Table 3. Second. there are 1. industry effect is not likely to be driving the results. more financially distressed (ZS)’ and have larger change in market risk (CHBETA) than firms before the requirement.e. 11. except for BIG5 and PSALE. two tests are conducted. industry dummies are added in eq.JOURNAL OF ACCOUNTING. The coefficients of correlation are small. 35.1 Descriptive Statistics Table 1 provides selected descriptive statistics of the variables of the sample. In this sample. Downloaded from jaf. Panel B shows information for the dummy variables. 36.611 (2. 12. The inferences of the variables are substantially the same as in column 3 of Table 4. the two-digit SIC industries are 28. In addition. the result of MODIFY suggests the rejection of Hypothesis 1.031) observations before (after) the disclosure requirement. To investigate industry effect further. AUDITING & FINANCE 98 were not available. the final sample consists of 3. The threshold is based on the entire sample. Specifically. 4. and 73.sagepub. observations in the business services industry (twodigit SIC code 73) are deleted from the sample because observations are more concentrated in the industry. A higher proportion of firms after the requirement have modified opinion (MODIFY and PMODIFY) and reported loss (ELOSS) than firms before the requirement. The sample was then restricted to financially distressed firms.” The results (available from the author) show that the main results as reported in column 3 of Table 4 are robust to the inclusion of the industry dummies. After deleting observations for the same firms that had a going concern opinion both before and after the disclosure requirement and observations that were more than four standard deviations from the means of the variables. firms after the requirement are less likely to be associated with Big 5 auditors (BIG5) than firms before the requirement. the means and standard deviations of the continuous variables are shown.945) between industry membership and classification of observations (i. ( I ) for industries that individually account for 5 percent or more of the sample. 38. the sign of the coefficients relating to modified opinion in the current year (MODIFY) is consistent with the prediction of the direction of the independent variables in eq. The sample is widely represented by the industries. The industry (defined by each two-digit Standard Industry Code [SIC]) distribution of the sample is shown in Table 2. In addition. Firms after the disclosure requirement are less profitable (PROFIT and ADJRET). clients are on average more important to their auditors after the disclosure requirement (PSALE). More important. In addition.com at Scientific library of Moscow State University on November 13. Moreover. First. 2013 . whether the observations are classified as before or after the disclosure requirement). A chi-square test suggests that there is no association ( p = 0. the sign of the coefficients relating to observations after the disclosure requirement (AFTER) supports the results in Table 1..

565*** 2.04 1) 1112 (0. MODIFY = 1 if the firm receives a going concern modified audit opinion in year t .047*** -0.TABLE 1 Selected Descriptive Statistics of the Variables of the Sample Panel A : Mean and standard deviation (in parentheses) of continuous variables with t-tests performed on the difference between means Before Disclosure Requirement ( n = 1.611) (b) After Disclosure Requirement (n = 2. Variable Definitions: LTA = natural logarithm of total assets PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat p in year t minus p in year t .390) 2. 2013 .560*** -0.262 (103. of auditor. or 0 otherwise = I if the firm has a reported loss in year t or year t . to total sales of all clients of auditor.027 0.213*** 0.152 (0.040) 4.01 level. or 0 otherwise ELOSS PMODIFY = I if the firm receives a modified audit opinion in year t .078*** (a) Variable MODIFY ELOSS PMODIFY BIGS -0. or 0 otherwise BIG5 = 1 if the firm's auditor in year t is a Big 5 auditor.1.827 (163.06 I (0.090) 1332 (0.097) 4.559) -0.031) 4.(b) Difference Between Proportions 67 (0.037) -0.835 (5.0 17 (0.738 (9.192*** -0.264) 8.224) 58.930 (11.690) 146 (0.127) (a) Variable LTA PROFIT CHBETA CFLOW ADJRET zs PSALE (c) = (a) . expressed in percentage zs = Z score PSALE = ratio of sales of client.556) -0.03 1 (0.031) ( c ) = (a) .012*** Panel B: Number and proportion (in parentheses) of firms having categorical variables designated as 1 with chi-square tests performed on the difference between proportions Before Disclosure Requirement ( n = 1.1 CFLOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market.005 50.com at Scientific library of Moscow State University on November 13.275 ( 1.1 19) 1497 (0.1 or.037*** 0.755) -0.557) 0.826) 242 (0.41 1 (2.127) 1575 (0.1 16) -0. or 0 otherwise Downloaded from jaf.384 (2.775) -0.(b) Difference Between Means 0.61 I ) (b) After Disclosure Requirement ( n = 2.022 (0.sagepub.05 1*** Note: *** designates statistical significance at the 0.189) 0.91 1) 0.737) 258 (0.019 (0.

05 3.91 I79 27 11.37 1.68 9 13 0.sagepub.100 JOURNAL O F ACCOUNTING. Commercial Machinery. Publishing and Allied Products Chemicals and Allied Products Petroleum Refining and Related Industries Rubber and Misc Plastics Products Leather and Leather Products Stone.72 155 13 9.44 0.06 26 1.49 9 18 0.06 6 2 0. Quarry Non-metal Minerals Building Construction-Gen Contr or Bldr Heavy Construction-Not Building Construction Construction-Special Trade Food and Kindred Products Tobacco Products Textile Mill Products Apparel and Other Finished Products Lumber and Wood Products.30 0.20 0.93 15 0.30 12 22 24 0.43 0.18 36 29 1. Computer Equipment Electr.05 0.06 0. Glass.49 2. 0 t h Elec Eq.13 0.81 199 10 9.05 0.55 0.06 0.43 9 0.44 3 41 I 10 50 4 15 15 0.30 0.50 181 8.43 137 8.64 27 19 1.74 1.35 0. Clay.61 23 70 4 4.68 1.25 67 5 0. Trans Equipment Industrial. 2013 . Concrete Products Primary Metal Industries Fabr Metal.46 0.12 0.74 4 0.05 1.19 2. Ex Furniture Furniture and Fixtures Paper and Allied Products Printing.62 0.1 I I97 39 9.89 1.10 0.com at Scientific library of Moscow State University on November 13.25 6 0.77 1.70 1.92 2 1 1 I 1 1 10 1. Hunting and Trapping Metal Mining Coal Mining Oil and Gas Extraction Mining.06 I I 26 1. AUDITING & FINANCE TABLE 2 Industry Distribution of the Sample Disclosure Requirement Before Two-Digit SIC Code 1 2 7 8 9 10 12 13 14 15 16 17 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 31 Description of Industry Agriculture Production-Crops Agriculture Production-Livestock Animal Spec Agricultural Services Forestry Fishing.74 0.25 4 0.49 17 1.68 35 Downloaded from jaf.62 0.44 0.20 7 0.80 0. Ex Cmp Transportation Equipment Number of Firms After Percentage Number of Firms Percentage 0.28 7 11 0.25 4 0. Ex Machinery.

00 11 1 4.39 2.30 0.3 1 0.12 0.30 0. (1) are reported in column 3 of Table 4. 2013 .00 2.79 0.61 I 100.031 100. this paper considers the likelihood of firms before the disclosure requirement receiving a going concern modified opinion if audit fees are Downloaded from jaf.90 2. Garden-Retail General Merchandise Stores Food Stores Auto Dealers.10 5 9 3 II 10 0.com at Scientific library of Moscow State University on November 13.15 1.04 I . (The results reported in columns 1 and 2 explain the analyses in Table 5).5 I 0. Services.62 16 II II 8 0.10 17. As shown.54 0.90 1.101 AUDIT OPINION AND DISCLOSURE OF AUDIT FEES 38 39 50 51 52 53 54 55 56 57 58 59 70 72 73 75 76 78 79 80 81 82 83 87 99 Total Meas Instr.44 I82 8. Other Lodging Places Personal Services Business Services Auto Repair.25 0. Hardware.43 0. auditors are more likely to issue a going concern modified audit opinion to their clients and the requirement is associated with higher auditor independence.17 0.7 1 8 0.05 0. Watches Misc Manufacturing Industries Durable Goods-Wholesale Nondurable Goods-Wholesale Building Materials.3 I 29 59 23 2 1.36 0. the evidence suggests that the null hypothesis be rejected. Resh. Gas Stations Apparel and Accessory Stores Home Furniture and Equipment Stores Eating and Drinking Places Miscellaneous Retail Hotels. Firms with lower stock return (ADJRET) and those that are more financially distressed (CFLOW and ZS) are also more likely to receive a going concern opinion.43 2.06 0.48 51 6 8 55 2.64 0.49 1.13 0.2 Results The results of logistic regression on eq. Hence.43 2. Thus.24 0.42 2.54 0.06 0. Acc.74 59 43 13 2 362 6 2 10 37 2. after the requirement.56 0. Re1 Services Nonclassifiable Establishments 152 9.25 16.25 0.sagepub.50 3 0. Next.39 39 35 7 4 263 4 1 9 28 2.33 0. Mgmt. firms with reported loss (ELOSS) and prior modified opinion (PMODIFY) are more likely to receive a going concern opinion in the current year.18 3.82 38 I 4 7 40 2. Parking Miscellaneous Repair Services Motion Pictures Amusement and Recreation Services Health Services Legal Services Educational Services Social Services Engr. Photo Goods.82 0.19 0.10 0.54 0.96 19 49 20 5 1.56 1.68 0. The dummy variable AFTER (for observations after the disclosure requirement) is positive and significant.

089*** -0.093*** 0.1.OOO (3) 1.10.OOO 0.0.064*** 0.322*** -0.051*** 1.016 -0.178*** 0.171*** -0.com at Scientific library of Moscow State University on November 13. 2001.000 0. 2013 (2) 1. 2000 *.130*** 0.025 -0.185*** -0.050*** 0.01 levels. or 0 if the AFTER observation relates to financial year-end after June 1. of auditor.642) TABLE 3 . and annual earnings announcement made before June 30. or 0 otherwise PMODIFY = 1 if the firm receives a modified audit opinion in year t .1 ELOSS = 1 if the firm has a reported loss in year t or year f .030* 0.134*** -0.138*** (4) (5) (6) (7) (8) (9) (10) -0.080*** 1.149*** 0.067*** 0.014 0.099*** 0.001 -0. to total sales of all clients of auditor.382*** -0.05.194*** -0. and annual earnings announcement made before June 30.sagepub.072*** -0.030* -0. PSALE = 1 if the observation relates to financial year-end after March 1. or 0 otherwise LTA = natural logarithm of total assets PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat p in year t minus 0 in year f .038** -0.OOO (12) Variable Definitions: MODIFY = 1 if the firm receives a going concern modified audit opinion in year f.OOO -0.101*** -0.000 0.052*** 0.073*** 0.1 lo*** 1.OOO 0.000 -0.018 0.021 -0.OOO 0.012 0.018 0. expressed in percentage ZS = zscore = 1 if the firm’s auditor in year t is a Big 5 auditor.094*** -0.064*** -0.163*** 0.103*** -0.002 0.254*** -0. respectively.103*** -0.280*** 1.051*** -0.058*** -0. or 0 otherwise BIGS = ratio of sales of client.000 -0. 1999.01 1 1.436*** 0.265*** -0.187*** 0..1 12*** 1. **.340*** -0.049*** (11) 1.006 (1) 1.254*** -0.000 -0.083*** 0.272*** -0.085*** 1..002 -0. Note: (1) MODIFY (2) LTA (3) PROFIT (4) CHBETA (5) ELOSS (6) PMODIFY (7) CFLOW (8) ADJRET (9) zs (10) BIGS (11) PSALE (12) AFTER Variable Pearson Correlation Matrix of the Variables of the Sample (n = 3.014 0.019 0. 2002.002 -0.1. or 0 otherwise CFLOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market. and *** designate statistical significance at the 0.420*** -0.043*** 0.110*** 0.001 -0. and 0.Downloaded from jaf.099*** 0.OOO -0.161*** 1.

01 levels.of auditor.459) 469. 2002.05 and 0.000)*** 0.367j -0.726 (O.168) 0. 1999.031) -5.087 (0.206 Notr: ** and ***designate two-tailed statistical significance at the 0..128) 0.056 (0.1 85 Before Disclosure Requirement ( n = 1.728 (0. and annual earnings AFTER announcement made before June 30.507 (0. respectively. PSALE = I if the observation relates to financial yearend after March 1.1.006 (O.619 (0.642) -5.119) 0.560 (0.OOO)*** -0. and annual earnings announcement made before June 30.086 (0.1.650 (0. 2001.000)*** -0. MODIFY) Parameter Estimate ( p value) Variable Predicted sign Intercept not applicable LTA 7 PROFIT - ELOSS + + PMODIFY t- CLFOW - ADJRET - CHBETA zs + BIGS PSALE AFTER 4 -2 log likelihood ratio ( p value) Pseudo R2 Full Sample ( n = 3.000)*** -0.0 10 (0.033 (0. Variable Defi'nitions: = 1 if the firm receives a going concern modified audit opinion in year t.000)*** -0.920 (0.452 (0.255 (0.com at Scientific library of Moscow State University on November 13.OOO)*** 0.289 (0.082 (0.729 (O.034 (0.AUDIT OPINION AND DISCLOSURE OF AUDIT FEES 103 TABLE 4 Audit Opinion Logistic Model for the Sample (the dependent variable is a going concern modified opinion./ient.006 (O. to total sales of all clients of auditor.OOO)*** -0.083 (O.78')) 2.190 (0. or 0 otherwise CLFOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market.OOO)*** -0.611) After Disclosure Requirement ( n = 2.I55) 0.015 (0.000)*** 0.01 I)** -0.121 -4.014)** 2. 2013 .041 (0.747 (0.753 (0. or 0 otherwise MODIFY = natural logarithm of total assets LTA PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat in year I minus in year t .158 (O.004)*** 0.073 (0. or 0 if the observation relates to financial yearend after June I .447) 0.227 (O.000)*** 747.367 (0.OOO)*** 2..OOO)*** -0.001)*** -0.227) -0.1 ELOSS = 1 if the firm has a reported loss in year t or year t . expressed in percentage zs = Z score = 1 if the firm's auditor in year t is a Big S auditor.014 (0.830) 1.502 (0. or 0 otherwise PMODIFY = 1 if the firm receives a modified audit opinion in year r .228) -0.304) 207.949) 2.7 16) 2.000)*** 2.003)*** -0. or 0 otherwise BIGS = ratio of sales of c.098 (0.250) 0.OOO)*** 0.sagepub.594 (0.432) -0.33 I (0.000)*** -0.2000 Downloaded from jaf.005 (0.129 (0.000)*** 0.

disclosed and the same likelihood for firms after the requirement if audit fees are not disclosed.078 0. but they would have had a higher average estimated probability (0.com at Scientific library of Moscow State University on November 13. in column c. ( I ) is run separately without the variable AFTER for observations before and after the disclosure requirement. Average actual and estimated probabilities are calculated by taking the mean of the probabilities for all clients in the particular subsample. According to Dye’s (1991) theory. eq.611) After disclosure requirement (n = 2. firms before the disclosure requirement should have a higher likelihood of receiving modified opinion if audit fees are disclosed and firms after the requirement should have a lower likelihood of the same if audit fees are not disclosed.119 0. the likelihood of firms after the disclosure requirement receiving a going concern opinion if audit fees are not disclosed is estimated by multiplying the estimated parameter values obtained for firms before the disclosure requirement by the values of firms’ characteristics after the requirement. the estimated parameter values obtained from the regression using firms after the disclosure requirement are applied to the values of firms’ characteristics before the requirement. the average actual probability of receiving a going concern modified opinion for firms before the disclosure requirement when audit fees are not disclosed is calculated from column 4 and the same probability for firms after the requirement when audit fees are disclosed is calculated from column 5.01 level. To estimate the likelihood of firms before the disclosure requirement receiving a going concern modified opinion if audit fees are disclosed.041 0. Then. Actual probability of receiving going concern modified opinion for observations before (after) the disclosure requirement is calculated from column 4 (5) of Table 4.03 1) Note: *** designates two-tailed statistical significance at the 0.078) of Downloaded from jaf. Estimated probability of receiving going concern modified opinion for observations before (after) the disclosure requirement is calculated by applying the estimated coefficients of the parameters in column 5 (4) Of Tdbk 4 to the value of clients’ characteristics before (after) the requirement. a t-test is performed on the difference between the average probabilities. The results show that firms before the disclosure requirement have an average probability (0.sagepub.104 JOURNAL OF ACCOUNTING.037*** 0.068 -0. The results of the logistic regressions are reported in columns 4 and 5 of Table 4. These estimated probabilities are reported in column b of Table 5. AUDITING & FINANCE TABLE 5 Average Actual and Estimated Probabilities of Receiving Going Concern Modified Opinion Average Actual Probability (b) Average Estimated Probability (c) = (a) .(b) Difference 0.051 *** (a) Finns Before disclosure requirement (n = 1. Similarly. 2013 . Such average actual probabilities are reported in column a of Table 5. Then. To proceed.041) of receiving a going concern modified opinion when audit fees are not disclosed.

and the results of other variables remain substantially unchanged as in column 3. additional analyses are preformed to investigate the following: (1) economic factors.1 Economic Factors In the sample period. As shown. First. a 15 percent limit for net income scaled by total assets is used. Hence. two tests are conducted. Thus. it is possible that more modified audit opinions may be issued during this time. In this sample. Hence. (1) is rerun and the results are reported in column 4 of Table 6. firms after the disclosure requirement have an average probability (0. (3) reporting accuracy. observations after the disclosure requirement do not differ significantly from those before in terms of LTA. observations after the disclosure requirement are matched with those before the requirement by industry and market-adjusted fiscal year-end annual stock return (ADJRET). observations after the disclosure requirement are matched with those before the requirement by industry (defined as each two-digit SIC) and net income (deflated by total assets).068) of receiving the same opinion if audit fees were not disclosed. there was a downturn in the economy and this might have had an adverse effect on firms’ financial results. The match produces 1. In this sample.3.sagepub. To ensure proper matching. the results of the variables remain substantially the same as in column 3 of Table 4. Once again. ADJRET. Second. More important. The match produces 1. and ZS (the results are available from the author). In other words. to further test the hypothesis.com at Scientific library of Moscow State University on November 13. PMODZFY. the variable BIGS is positive and significant. CFLOW. AFTER is positive and Downloaded from jaf. Again. Dye’s (1991) theory is supported. and BIG5 (the results are available from the author). the difference in average probabilities is statistically significant. 4.3 Additional Tests A caveat in the interpretation of the results is that other factors may be driving them. observations with net income scaled by total assets that are 15 percent higher or lower than their matched pairs are deleted. Logistic regression on eq. (1) is rerun and the results are reported in column 3 of Table 6. To address this possibility. The difference in average probabilities is statistically significant. Logistic regression on eq. the cutoff limit is increased to 50 percent. 4. 2013 .059 pairs of observations. As shown.AUDIT OPINION AND DISCLOSURE OF AUDIT FEES 105 receiving the same opinion if audit fees were disclosed. In addition. As the dispersion of ADJRET is wider. observations after the disclosure requirement do not differ significantly from those before the requirement in terms of net income deflated by total assets. but they would have had a lower average estimated probability (0.133 pairs of observations.1 19) of receiving a going concern modified opinion when audit fees are disclosed. (2) auditor reporting conservatism. and (4) length of sample period. AFTER is again positive and significant.

356) -0. respectively.OOO)*** 0.030 (0.003 (0.OOO)*** -1.003 (0.628 (0.005 (0.7 I8 (O.266) Parameter Estimate ( p value) Parameter estimate ( p value) -5.774) 0.064 (0.938 (0.OOO)*** -0.651) 2.000)*** 461. AUDITING & FINANCE 106 TABLE 6 Audit Opinion Logistic Model for the Sample Matched by Financial Performance (the dependent variable is a going concern modified opinion.626) -0.182) 0.01 1 (0.005)*** -0.1 CHBETA f.899 (O.733 (0.138 (O.OOO)* ** -0.OOl)*** BIG5 PSALE AFTER -2 log likelihood ratio ( p value) Pseudo R2 366.049 (O.036 (0.085 (0.sagepub.066 (O.392) 0.983) 1.OOO)*** 0.OOO)*** -0.135 (0.058 (0.000)*** 0. MODIFY) Sample Matched by Variable Predicted Sign Intercept not applicable LTA ? PROFIT CHBETA L ELOSS PMODIFY CLFOW ADJRET Net income divided by total assets ( n = 2.470) 0.002)*** -0. Downloaded from jaf.075 (0. Variable Definitions: = 1 if the firm receives a going concern modified audit opinion in year MODIFY LTA = natural logarithm of total assets PROFIT = ratio of operating income after depreciation to sales = Compustat p in year t minus p in year t .05 and 0.118) Market-adjusted fiscal year-end annual stock return ( n = 2.405 (O.01 levels.382 (O.005)*** -0.OOO)** * 2.004 (0.028)** 0.JOURNAL OF ACCOUNTING.1 13 (O.com at Scientific library of Moscow State University on November 13. 2013 or 0 otherwise .001)*** zs -0.346 (O.OOO)*** 0.483 (O.731) 2.184 Note: ** and *** designate two-tailed statistical significance at the 0.OOO)*** 2.158 -5.976 (0.

the issue is investigated by using discretionary accruals as a measure of auditor reporting conservatism (because DeFond and Subramanyam [ 19981 report that firms that change auditors are treated more conservatively by the outgoing auditors who are associated with significantly negative discretionary accruals). and annual earnings announcement made before June 30. to total sales of all clients of audiror. or 0 otherwise 1 if the firm receives a modified audit opinion in year t . To see this. the results are robust to the control for the possible effect of economic factors. or 0 if the observation relates to financial year-end after June I .com at Scientific library of Moscow State University on November 13. More modified opinions may be issued if auditors become more conservative following the debate. is carried over to a period that occurs after the final rule.. if any. or 0 otherwise = ratio of sales of client. 1999. 2000 = = significant. there is no a priori reason to suggest that the debate necessarily results in improved auditor independence. the results are free from the effect of the debate. if any..1. 2002.3. the necessary data are collected from Compustat to estimate. This test is done to alleviate concern that the debate may affect auditor independence if its effect. and annual earnings announcement made before June 30. but conservatism affects the materiality threshold to define what constitutes material errors. or 0 otherwise ratio of cash flow from operation to total assets fiscal year-end annual stock return minus return of the market.I . on a year-by-year basis.2 Auditor Reporting Conservatism There was debate on auditor independence preceding the SEC’s (2000) final rule on disclosure of nonaudit (and audit) fees. but they may not report the detected errors because of various forces that induce them to remain silent (e. 2001.1 if the firm’s auditor in year t is a Big S auditor. To proceed.. conservative auditors will adopt a lower materiality threshold to define what constitutes material errors.g.sagepub. Despite the above arguments.AUDIT OPINION AND DISCLOSURE OF AUDIT FEES ELOSS PMODIFY CLFOW ADJRET zs BIGS PSALE AFTER = = 107 1 if the firm has a reported loss in year t or year t . fear of losing clients).. expressed in percentage .. Thus. of auditor. then improved auditor independence following the disclosure of audit fees is not likely to be the result of the debate. Independence is the likelihood that auditors report detected material misstatements in audited financial statements (DeAngelo [ 198 1b]). Hence. = I if the observation relates to financial year-end after March I .Z score . Furthermore. Hence. To control for such possibility. The rationale is that if auditors are not more conservative during the disclosure period than during the predisclosure period. discretionary accruals using Downloaded from jaf. the period from the preliminary rule to the final rule has not been included in the sample. note that conservatism is distinct from independence. 2013 . 4. conservatism affects the finding of material errors. In other words. but independence is the reporting of those errors as determined by conservatism.

com at Scientific library of Moscow State University on November 13. Observations after the disclosure requirement are then matched with those before the disclosure requirement on the bases of each two-digit SIC industry. and added separately) in the regressions. Jones’ (1991) model estimates the following equation. LOSS and PLOSS are significant. plant. observations with discretionary accruals that are 50 percent higher or lower than their matched pairs are deleted. All other variables are the same as in Jones’ (1991) model in note 13. The results of the regression are reported in Table 7. sales revenue in year t minus sales revenue in year r . In other words. plus the change in debt included in current liabilities. Though the observations are matched by discretionary accruals estimated by Jones’ (1991) model. As shown. AFTER is positive and significant. and (signed and not absolute value of) discretionary accruals.’s (1995) model. Discretionary accruals are then estimated by the difference between actual total accruals and expected total accruals cakulated by the estimated parameters. These criteria produced 609 pairs of observations. producing 3. TA = b + cCHSALES + dPPE where TA = total accruals in year t . the variable ELOSS is replaced by LOSS and PLOSS. 15.JOURNAL OF ACCOUNTING. and minus depreciation and amortization expense. + Downloaded from jaf. and equipment in year r parameters to be estimated by regression = CHSALES = PPE b. a 50 percent limit for discretionary accruals is used. AUDITING & FINANCE 108 the Jones’ (1991) model for industries (defined by each two-digit SIC) that had at least eight firms.I . 14. observations after the disclosure requirement do not have significantly higher or lower discretionary accruals than those before the requirement for each auditor14 (the results are available from the author).13 After estimating discretionary accruals.1 gross property. observations after the disclosure requirement also do not differ from those before the requirement in terms of discretionary accruals estimated by Dechow et al. Hence. 2013 . c . auditor reporting conservatism and the effect of the debate are not likely to be driving the results. while the inferences of other variables remain substantially the same as in column 3 of Table 4. To ensure proper matching.’s 1995 model. 13.sagepub. to facilitate estimation of eq. In this sample.’s (1995) model estimates the following equation: TA = b c(CHSALES . In addition.15More important. respectively. minus the change in cash and cash equivalent. d = All the terms are scaled by the preceding year’s total assets to reduce the problem of heteroscedasticity.CHREC) + dPPE where CHREC equals net receivable in year r minus net receivable in year t . which are dummy variables for observations with reported loss in the current year and the last year. measured as the change in current assets minus the change in current liabilities. the sample of discretionary accruals is merged with the sample firms. This relationship of ELOSS with MODIFY will produce a quasi-complete separation of data points for ELOSS and make the parameter estimate of ELOSS unreliable in logistic regression. Hence. individual auditor.526 observations with discretionary accruals. The results in Table 7 also hold with the addition of discretionary accruals (estimated by both Jones’ [1991] model and Dechow et al. Dechow et al. (l). all observations with a going concern opinion (MODIFY) have reported loss in either the last or the current years (ELOSS).

or 0 otherwise LTA .01 levels.OOO)*** -0.218) Variable Predicted Sign Parameter Estimate ( p value) Intercept not applicable -6..97 1 (0.725 (0. or 0 otherwise PMODIFY = 1 if the firm receives a modified audit opinion in year t . of auditor. expressed in percentage zs .1 LOSS .6 18) 1..367) -0.05 and 0. 2000 Downloaded from jaf.1 if the firm has a reported loss in year t .722) 0.OOO)*** 0.044 (0.Z score BIG5 . or 0 otherwise PLOSS = 1 if the firm has a reported loss in year t .1 if the firm’s auditor in year t is a Big 5 auditor. 2001.152 (O.natural logarithm of total assets PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat p in year I minus p in year 1 .sagepub.161 Note: **and *** designate 2-tailed statistical significance at the 0. Variable Definitions: MODIFY = 1 if the firm receives a going concern modified audit opinion in year t.013 (O.778 LTA ? PROFIT - LOSS + + PLOSS + PMODIFY + CLFOW - ADJRET - zs - BIG5 + PSALE - AFTER 4- CHBETA (0. 1999. or 0 if the observation relates to financial year-end after June I .103 (0. 2013 .016)** 2. or 0 otherwise PSALE = ratio of sales of client.003)*** -0. MODIFY) (n = 1.003)*** 0. and annual earnings announcement made before June 30.356) -0.012 (0.TABLE 7 Audit Opinion Logistic Model for the Sample Matched by Discretionary Accruals (the dependent variable is a going concern modified opinion.ooO)*** -0. to total sales of all clients of auditor.com at Scientific library of Moscow State University on November 13.009 (O.I .016)** -2 log likelihood ratio ( p value) Pseudo R2 215.619 (O.427 (0.620) -0. and annual earnings announcement made before June 30.1. or 0 otherwise CLFOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market. respectively. 2002.591 (0. AFTER = 1 if the observation relates to financial year-end after March 1.059 (0.OOO)*** 0.330 (0.40 1) 0.

it is desirable to examine whether the higher auditor independence suggested by the results also extends to a later period. The sample selection procedures are repeated and the new sample consists of 3. The results of the regression using this sample are reported in Table 8. which may mean the occurrence of more Type I errors. and management discussion is obtained from the Disclosure database.3. At the same time.362 observations. in fact. Hence. In this sample. 2003. firms that receive a going concern opinion but are not classified as bankrupt (Type I error case). a going concern. and CFLOW is insignificant. The new sample consists of 4. the consequence of committing a Type I1 error is more serious for the auditors. and firms that receive a clean opinion but are classified as bankrupt (Type I1 error case) are deleted. In Section 4. observing ex post a Type I error may not mean that auditors are conservative ex ante. 2002. 4. in fact. AUDITING & FINANCE 110 4. auditors’ reporting accuracy is not likely to be driving the results. Hence. One way to avoid committing a Type I1 error is to report more conservatively. but the results of the other control variables are substantially the same as in column 3 of Table 4.4 Length of Sample Period The disclosure period in the sample is limited to June 30. auditors’ reporting conservatism is controlled for. As shown. To further control for auditors’ reporting accuracy.BankruptcyData. because it is possible that firms’ financial condition may improve unexpectedly subsequent to the receipt of a going concern opinion. More important.sagepub.904 observations. 2013 .3 Reporting Accuracy If an auditor issues a going concern opinion to a client that is. The purpose is to identify cases in which auditors’ reporting is likely to be accurate. not a going concern. In addition. to have a sample that is reasonably free from the influence of the Sarbanes-Oxley Act.com) and the Disclosure database. or if the management gives warning of filing for bankruptcy in the management discussion section of the annual reports. and the main results in column 3 of Table 4 are robust. If the auditor issues a clean opinion to a client that is. while committing a Type I1 error may result in litigation against auditors should the client go into bankruptcy after receiving a clean opinion.3. of which 1. A dummy variable AFTER2 is added to eq. he or she commits a Type I error. Information on firms’ bankruptcy is obtained from the provider (www. 2002. and March 31.838) are observations before (after) the disclosure requirement.524 (1.com at Scientific library of Moscow State University on November 13. Therefore. the sample is expanded to include observations for firms that have annual earnings announcement between July 1. a new sample is selected. (1) for the later Downloaded from jaf. Firms are identified as bankrupt if they file for bankruptcy in the current year or within twelve months following their annual earnings announcement.JOURNAL OF ACCOUNTING. LTA and BIG5 are significant. Committing a Type I error may result in losing the particular client. he or she commits a Type I1 error. and they are more likely to try to avoid committing this type of error.3. the variable of interest AFTER is still positive and significant.2.

000)*** -0. or 0 otherwise PMODIFY = 1 if the firm receives a modified audit opinion in year I .298) -0.326) -0.115) 4.689 (0.006)*** 2.049 (0.000)*** -0. respectively.362) Variable Predicted Sign Intercept not applicable . AFTER = I if the observation relates to financial year-end after March I . or 0 otherwise LTA .com at Scientific library of Moscow State University on November 13.012)** 2. expressed in percentage zs . of auditor.natural logarithm of total assets PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat p in year I minus !3 in year t .250 (O.I if the firm’s auditor in year t is a Big 5 auditor.sagepub.OOO)*** 1.OOO)*** 0. 2002.014 (O.560 (0.. Variable Definitions: MODIFY = I if the firm receives a going concern modified audit opinion in year t.007 (0.OOO)*** 0.I ELOSS = 1 if the firm has a reported loss in year t or year t .002)*** 239..Z score BIGS .020 (O.1. and annual earnings announcement made before June 30. or 0 if the observation relates to financial year-end after June I . 2013 . 1999.173) 1. or 0 otherwise CLFOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market. or 0 otherwise PSALE = ratio of sales of dient.01 levels.850 (O. and annual earnings announcement made before June 30.OOO)*** -0. MODIFY) (n = 3.TABLE 8 Audit Opinion Logistic Model for the Sample Without Type I and Type I1 Errors (the dependent variable is a going concern modified opinion.294 (0. LTA PROFIT CHBETA ELOSS PMODIFY CLFOW ADJRET zs BIG5 PSALE AFTER -2 log likelihood ratio ( p value) Pseudo R’ Parameter Estimate ( p value) . 2000 Downloaded from jaf.I .007 (0. 2001.042 (0. to total sales of all clients of auditor.858 (0.068 Note: ** and *** designate two-tailed statistical significance at the 0.05 and 0.12.313 (0.

audit firms are more likely to issue a going concern modified audit opinion to their clients. Hence. results of studies that link quasi-rents to auditor independence. measured in terms of the likelihood of issuing modified audit opinion by auditors. they are not observable publicly. In addition. auditor reporting conservatism. Hence. Using U. Hence. 2003. More important. will be improved if audit fees are disclosed. Dye’s (1991) theory suggests that auditor independence will be improved following disclosure of audit fees.4 Limitations Some limitations of this paper should be noted. should be interpreted cautiously because of the imprecision of the measurement of quasi-rents. 2013 . Although quasi-rents are important in the auditing literature. 5. like others that are based on the theory of quasi-rents. AFTER is redefined as 1 if the observation relates to financial year-end after March 1. and auditor reporting accuracy. or 0 otherwise.com at Scientific library of Moscow State University on November 13. firms before (after) the disclosure requirement are 16. Downloaded from jaf. Thus. LTA and PROFIT are significant and the results of the other control variables are substantially the same as in column 3 of Table 4. proxied by the issuance of audit opinion or other measures. AFTER2 takes the value of I for observations with annual earnings announcement date between July 1. In addition. because auditors who receive zero quasi-rents will incur lower legal costs.S. and annual earnings announcement made before June 30. Conclusion This paper investigates whether auditor independence. Hence. DeAngelo’s (1981a) theory implies no relationship between audit opinion and disclosure of audit fees. Thus. there are no quasi-rents to influence auditors’ reporting decision. attempt to measure quasi-rents by using fee measures or other proxies. the results of this paper. this paper reports that after the disclosure requirement of the SEC (2000). On the other hand. Consequently. and March 31. auditors could not signal accurately to outsiders the amount of future quasi-rents in their audit engagements. including this one. higher auditor independence in the disclosure period persists to a longer period and is not likely to be due to the length of sample period chosen.sagepub. or 0 otherwise. Such discounts arise from the transaction costs of auditors and clients and will not be affected by disclosure of audit fees. 2002. 2001. data.112 JOURNAL OF ACCOUNTING. This result is robust to the control for the possible effect of economic downturn. As shown. 2002. DeAngelo (1981a) suggests that audit opinion will not be affected by initial audit fee discounts because the discounts are sunk costs. Dye (1991) argues that when audit fees are disclosed. 4. both AFTER and AFTER2 are positive and significant.I6 The results of regression are reported in Table 9. are only as good as those proxies for quasi-rents. outsiders could not assess precisely auditor independence using those proxies for quasi-rents. These proxies may not capture quasi-rents precisely. empirical studies. AUDITING I% FINANCE disclosure period.

respectively. AFTER = I if the observation relates to financial year-end after March I ..904) Variable Predicted Sign Intercept not applicable LTA ? PROFIT - ELOSS + + PMODIFY + CLFOW - ADJRET - zs - BIG5 + PSALE - AFTER + AFTER2 + CHBETA Parameter Estimate (p value) -5.243 Note: *. or 0 otherwise ELOSS = 1 if the firm has a reported loss in year t or year t PMODIFY = I if the firm receives a modified audit opinion in year t . and 0.906 (0.278) 2.. 2013 .120) 0.OOO)*** -0.260 -2 log likelihood ratio ( p value) Pseudo R2 (O.005 (O.I 1. Variable Definitions.072 (0. to total sales of all clients of auditor.099 (0.TABLE 9 Audit Opinion Logistic Model for the Expanded Sample (the dependent variable is a going concern modified opinion. 2002. 2002. 2001. or 0 otherwise CLFOW = ratio of cash flow from operation to total assets ADJRET = fiscal year-end annual stock return minus return of the market.OOO)*** -0.OOO)*** -0.053 (O.001)*** 0. or 0 otherwise AFTER2 = I annual earnings announcement is made within July 1.049)** -0.natural logarithm of total assets LTA PROFIT = ratio of operating income after depreciation to sales CHBETA = Compustat p in year t minus !3 in year t .014 (0. **' and *** designate two-tailed statistical significanceat the 0.975 (O.331 (O.OOO)*** -0.1 if the firm's auditor in year t is a Big 5 auditor. and annual earnings announcement made before June 30.OOO)*** ~ 1369.219 (O. and March 31. 0.986) 0. 2003. of auditor.OOO)*** 0.OOO)*** 2. MODIFY = I if the firm receives a going concern modified audit opinion in year t.com at Scientific library of Moscow State University on November 13.01 levels.OOO)*** 0. or 0 otherwise PSALE = ratio of sales of client.sagepub.002 (0.061)* 0. or 0 otherwise . or 0 otherwise ~ - Downloaded from jaf.765 (0.05.1. expressed in percentage zs . MODIFY) ( n = 4.920 (O.10.081 (O.Z score BIG5 .

onomic. Geiger. “A Reexamination of Auditor Versus Model Accuracy within the Context of the Going-Concern Opinion Decision.s 14 (December): 347-374. 2000. Forthcoming. and J . 1987.. 43. Francis. M. the results are consistent with Dye’s (1991) theory and contribute to the literature by suggesting that disclosure of audit fees is relevant.” Auditing: A Journal of Practic~. R. M.September 3): 7.” Auditin. R. G. AUDITING & FINANCE found to be more (less) likely to receive a going concern opinion if audit fees were (were not) disclosed.. Washington. “Predicting Audit Qualifications with Financial and Market Variables.s 3 (August): I 13-1 27.onomic. LaFond.. 1995. Leftwich. R. 2000. M.” Journal qf Awounting Research 29 (Autumn): 193-228.counting Review 63 (October): 663482. P. 1991. Wilson. and E..y 1 I (Fall): 3 W 9 . R. McKeown. “Earnings Management during Import Relief Investigations. Securities and Exchange Commission. 1994. Defond. “Auditor Size and Audit Quality. 62 (July): 43 1454.5. Dechow. R. and Abnormal Accruals. R. S. W. “Do Nonaudit Service Fees Impair Auditor Independence? Evidence from Going-Concern Audit Opinions.. Chung. Subramanyam. Mutchler.” The Ar. 1998. and K.and T//eo. J.. disclosure of audit fees improves auditor independence.. 2003.” Tlir Accounting Rei. 78 (July): 61 1 4 3 9 . L. Raghunandan. Jones. Mutchler. A.com at Scientific library of Moscow State University on November 13. J. 2002.ounfinLF Revirw 74 (April): 201-21 6. Frankel.sagepub.” Tlic. Ac. “Auditor Tenure and Audit Reporting Failures. and A. Ashbaugh. REFERENCES Accounting Today.. F. C. McKeown. DeAngelo. K. Thus.” Journal of Accounting and E(. Mayhew.” Journal of Accounting and Economics 3 (December): 183-199. and K. Nelson. Hopwood. and G. Dopuch. Stice. Proposed Rule: Revision of the Commission’s Auditor Independence Requirements. D. 2002. 1993.-C. L.114 JOURNAL OF ACCOUNTING. “Detecting Earnings Management. R. DC.” The Accmntin. 198la. R. 1997. Church.y: A Journal of Pructicv and Theory. “The Influence of Contrary Information and Mitigating Factors on Audit Opinion Decisions on Bankrupt Companies..” Journal of Accourztirrg Reseurdi 35 (Autumn): 295-3 10. Tseng. 1992. W.li 40 (September): 1247-1 274. Krishnan. Teh. 2002. Raghunandan. 1991. M. “Auditor Independence.. 199 1 . W. “Auditor Changes: A Joint Test of Theories Relating to Agency Costs and Auditor Differentiation. and M. Sweeney. “Client Importance. 1981b. 1990.. T.” The Accounting Review 70 (April): 193-22. N. M. and S. G. J. “Pricing Initial Audit Engagements: A Test of Competing Theories.” Tllr Accountin<?Revirw..” Contemporary Auwunting Rrsearch 1 0 (Spring): 4 0 9 4 3 1. A. Sloan. J. and B. A. “Using Financial and Market Information to Identify Pre-engagement Factors Associated with Lawsuits against Auditors. Jaggi. Magee. F. R. 2003. Overall. Kallapur.r und Theory 21 (March): 67-78. S. Hopwood. DeAngelo. and J. K. Francis. ‘Low Balling’.” The Accounting Review’ 78 (October): 93 1-955. 77 (Supplement): 71-105. Downloaded from jaf. F.. Johnson. and R. and B.. W. Holthausen. “Do Non-audit Services Compromise Auditor Independence’? Further Evidence.” Journal of Accountin<?and E(. and K. K.iews 66 (July): 5 16-533.” Journal of Accountin.counring Rei. C.” Joirrnal of Accoimtincq and Economic. Chen. P..” The Ac.” Auditing: A Journal of Practic. and S. W. Craswell.” Tlir Accmnting Review 65 (April): 315-336. “Predicting Uncertainty Audit Qualifications in Australia Using Publicly Available Information. and K. 2013 .ieM. 1988.c. 1999. L.” Accounting cmd Financv 33 (November): 79-106. J.? Researc. R. SEC (Securities and Exchange Commission). “Audit Pricing and Independence.s 25 (February): 35-67. “Informationally Motivated Auditor Replacement. B. T. “Auditor Changes and Discretionary Accruals. and J. “The Relation between Auditors’ Fees for Nonaudit Services and Earnings Management. H.. W. Gul. Subramanyam. “Auditor Independence: Evidence on the Joint Effects of Auditor Tenure and Non-audit Fees. M. J. H. and Disclosure Regulation. Dye. A.? ReL’iew. L. “Will History Repeat Itself at the Commission’?’’ (August 21 . P. “Default on Debt Obligations and the Issuance of GoingConcern Opinions. DeFond. Monroe. Non-audit Services.