Audit and Non-audit Fees and Capital Market Perceptions of Auditor Independence

Audit and Non-audit Fees and Capital Market Perceptions of Auditor IndependenceAloke Ghosh Aloke_Ghosh@baruch.cuny.edu Stan Ross Department of Accountancy Baruch College, The City University of New York (646) 312-3184 Fax: (646 312-3161) Sanjay Kallapur kallapur@mgmt.purdue.edu Krannert School of Management Purdue University and Indian School of Business Gachibowli, Hyderabad 500019 +91 40 2318 7138 Fax: +91 40 2300 7038 and Doocheol Moon moond@oldwestbury.edu SUNY - Oldwestbury (516) 876-3163 Fax: (516) 876-3360 First draft: April 2004 Current draft: March 2006 A substantial part of this paper was completed while Aloke Ghosh was visiting the Securities and Exchange Commission. We thank seminar participants at the University of Cincinnati for helpful comments. Audit and Non-audit Fees and Capital Market Perceptions of Auditor Independence Abstract This study investigates investor perceptions, proxied by earnings response coefficients (ERCs), of auditor independence-in-appearance as a function of audit and non-audit fees. For a sample of 8,940 firm-years over the 2000-2002 period, we find in separate regressions that ERCs are negatively associated with the ratio of non-audit to total fees (non-audit fee ratio) and with client importance (auditors’ fees from a given client divided by auditor’s total revenues). When we include both in the same regression however, only client importance remains significantly associated ...