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Auditing: A Journal of Practice & Theory American Accounting AssociationVol. 27, No. 2 DOI: 10.2308/aud.2008.27.2.31November 2008pAuditor Independence andAuditor-ProvidedTax Service: Evidence from Going-ConcernAudit Opinions Prior to Bankruptcy Filings

Dahlia Robinson

SUMMARY: This study examines whether auditors provision of tax services impairsauditor independence by focusing on auditors going-concern opinions among a sampleof bankruptcy filing firms. The evidence from the bankruptcy setting is particularly sa-lient given that the bankruptcy of corporations such as Enron motivated several provi-sions of the Sarbanes-Oxley Act SOX of 2002. More recently, auditors provision of taxservice to their audit clients has been the focus of new rules by the Public CompanyAccounting Oversight Board PCAOB. Consistent with improved audit quality frominformation spillover, the study documents a significant positive correlation between thelevel of tax services fees and the likelihood of correctly issuing a going-concern opinionprior to the bankruptcy filing. One implication of this result is that restricting tax servicesby auditors of poorly performing firms may diminish the quality of auditors reportingdecisions without leading to an improvement in auditor independence.

Keywords: auditor independence; tax service fees; going-concern qualification; infor-mation spillover.

Data Availability: The data are available from public sources cited in the paper.

INTRODUCTIONInvestor confidence in the quality and integrity of publicly available corporate financial in-

ormation prepared by public companies and certified by independent auditors is considered vitalo the proper functioning of U.S. capital markets. Beginning in the late 1990s, the Securities andxchange Commission SEC became increasingly concerned that the growth of nonaudit servicesrovided to audit clients could undermine that confidence. The SEC feared a potential erosion ofuditor independence caused by economic self-interests of audit firms in the provision of nonauditervices NAS. The perceived link between the provision of NAS and degraded independenceltimately encouraged the SEC to impose new rules restricting certain types of NAS that auditrms could provide for their audit clients and requiring new proxy disclosures by registrants of theagnitude of audit fees and several categories of nonaudit fees SEC 2000.

ahlia Robinson is an Assistant Professor at the University of South Florida.

his paper benefits from comments from Mark Dawkins, Lisa Gaynor, Donald Goldman, Yuchang Hwang, Jennifer Kahle,

p. 3154enock Louis, Michael Mikhail, Jackie Reck, Philip Reckers, Michael Robinson, Nathan Stuart, workshop participants atrizona State University, and two anonymous reviewers.

Submitted: February 2007Accepted: May 2008

Published Online: March 2009

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AAWith the adoption of these new SEC final rules in early 2001, concerns about auditor inde-endence and nonaudit service diminished until the much-publicized bankruptcies of Enron,orldCom, and Global Crossing1 catapulted these two issues to the forefront depicting the audit

rm as a collaborator in deception Reynolds et al. 2004, 29 and motivated several provisionsf the Sarbanes-Oxley Act SOX of 2002 Oates 2002; Reynolds et al. 2004. In commentaries onhese failures, the press highlighted the large numbers of bankruptcy filings in which auditorsailed to issue a going-concern qualification in the audit opinion issued immediately prior to thelings, and often cited these cases as evidence of lack of auditor independence Hilzenrath 2001;eil 2001, 2003; Dietz 2002; Venuti 2004. Further, this diminished independence was often

inked to the provision of nonaudit services Weil 2003; Venuti 2004; Lindberg and Beck 2004.2iven this perceived link between degraded auditor independence and the provision of NAS inankruptcy filing firms, this study examines the association between auditor independence prox-ed by auditors issuance of going-concern opinions and auditor-provided tax services amongankruptcy-filing firms.

Several studies investigating the relation between auditor independence and NAS infer auditorndependence by the clients financial reporting quality, generally proxied by the level of account-ng accruals or whether the firm meets/beats earnings forecasts for example, Frankel et al. 2002;ntle et al. 2002; Ashbaugh et al. 2003; Chung and Kallapur 2003; Francis and Ke 2003;eynolds et al. 2004; Larcker and Richardson 2004. One clear advantage of utilizing the going-oncern modified audit opinion compared to accounting accruals or meeting/beating earningsorecasts is that the going-concern opinion is a direct outcome of the auditors decisions andctions taken during the audit.

A number of other studies for example, Sharma and Sidhu 2001; DeFond et al. 2002; Geigernd Rama 2003 also utilize the going-concern decision to investigate whether the provision ofAS impairs auditor independence. However, by looking at nonaudit fees in the aggregate, these

tudies seem to imply that all nonaudit services have the same impact on the audit decision.owever, Francis 2004 suggests that tax service is the one area of nonaudit service that would be

ikely to benefit the audit. Accordingly, in this study, I disaggregate nonaudit fees into a tax and aontax component.

My focus on the tax service component of nonaudit services is also motivated by recent SECules and SOX provisions that allow auditor-provided tax services while banning several types ofther nonaudit services. Implicitly, this suggests that regulators and legislators believe that auditor-rovided tax services are less likely to impair independence, and may even improve the audithrough knowledge transfer. As the SEC itself acknowledges, the review of the registrantsax returns and reserves require substantial knowledge about the audit client Sage and Sage005, 31.

Simunic 1984 provides a model of knowledge spillovers or cost interdependencies thatelate to client-specific spillovers in which NAS such as tax service may complement the auditnd enhance audit quality. Such knowledge spillovers occur because the audit and tax servicesequire elements of the same information set and/or the same professional qualifications. In fact,rancis 2004, 363 suggests that the one area of nonaudit service in which knowledge spilloverould seem plausible is the joint preparation of tax returns and the audit of tax-related accounts

n the financial statements. Consistent with information spillover, Kinney et al. 2004 provide

Other large corporations filing for bankruptcy during this period include Adelphia Communications, Conseco Inc., UALCorp., Pacific Gas and Electric, Kmart Corp., The Finova Group, NTL, Reliance Group Holdings, and Federal Mogul.These 12 corporations had combined assets of $381 billion at the time of filing Venuti 2004.A study by Bloomberg News reports that in 54 percent of the 673 largest bankruptcies of public corporations since 1996,auditors provided no warnings in annual financial statements issued in the months before bankruptcy Dietz 2002.uditing: A Journal of Practice & Theory November 2008merican Accounting Association

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Auditor Independence and Auditor-Provided Tax Service: Evidence from Going-Concern Audit Opinions 33

Aome empirical evidence that financial reporting quality measured as firms propensity to restatereviously filed financial statements is higher for firms that purchase larger amounts of taxervices from the incumbent auditor.

In the specific context of the going-concern qualification, Goldman 2006 suggests thatoorly performing firms potentially have an enhanced need for some types of tax planning. Suchax planning strategies, for example, may help these firms maximize taxable losses resulting in taxefundsan important issue for cash-strapped, poorly performing firms. Having the tax managernd partner involved in corporate tax compliance and planning also provides more general scru-iny of the transactions of the firm. For example, a taxpayer with going-concern problems is moreikely to have loss carryforwards in some or many jurisdictions. Growing operating and capitaloss carryforwards require tax planning to prevent loss expiration. Participating in such tax plan-ing makes the tax partner and manager better informed about the need for a valuation allowance,hich is related to going-concern risk. Thus tax compliance and planning work can potentially

ead to information spillover that improves audit quality.3,4Despite these potential positive effects of auditor-provided tax services on audit quality, recent

ublic Company Accounting Oversight Board PCAOB initiatives targeted specifically at prohib-ting auditor-provided tax service appear to be driven by concerns that auditor independence wille compromised by the additional fees from tax services PCAOB 2004. More specifically, theCAOB indicated concerns that auditor-provided tax service could impair auditors independence,nd concluded that imposing more stringent ethical and independence requirements with respect toertain tax services is necessary to restore public confidence in the ethics and independence ofublic company auditors PCAOB 2004. The SEC recently approved the PCAOB rules on auditorndependence, thus limiting the types of tax services independent auditors may provide to theirEC audit clients SEC 2006.5 Thus, the renewed legislative efforts to restrict auditor-provided

ax services suggest a need for academic research on this issue, which is the purpose of this study.Using a sample of 209 firms filing for Chapter 11 bankruptcy, I find no empirical evidence

hat auditor independence is compromised by the provision of tax services. Specifically, I find aositive and significant relation between the likelihood of correctly issuing a going-concern opin-on in the last audit report prior to the bankruptcy filing and the level of tax services fees. I find noignificant correlation between the going-concern opinion and either audit fees or the nontaxomponent of nonaudit fees. This result holds even after controlling for unexpected fees and forndogeneity among audit, nonaudit, tax, and nontax NAS fees. The positive relation betweenuditors issuance of going-concern opinions and tax fees is inconsistent with concerns about

Goldman 2006 a retired tax partner from a Big 4 audit firm observes that such information spillover from taxcompliance and tax planning work is not uncommon. One specific example of information spillover aiding the going-concern audit opinion involved a client that had made a loan to the CEO, who was also a founder. The loan was securedby property purchased with the proceeds from the loan. During tax work related to a joint-venture project to develop theland, it became clear that the land was acquired for far more than it was worth. This information directly led to therequirement for a reserve related to this loan during the audit, which threatened the firms going-concern status.Information spillover is less likely with other types of NAS such as information systems design and implementationwork, given the nature of these tasks.Sample firms disclosures in pre-filing 10-Ks provide corroboration for Goldmans 2006 suggestion that distressedfirms may have an enhanced need for some types of tax planning. Many of these firms discuss the need to implementtax-planning strategies in order to ensure that the benefit of tax carryovers and credits are fully realized.The rules identify circumstances in which the provision of tax services impairs an auditors independence, includingservices related to marketing, planning, or opining in favor of the tax treatment of, among other things, transactions thatare based on aggressive interpretations of applicable tax laws and regulations. The rules also treat registered publicaccounting firms as not independent of their audit clients if they enter into contingent fee arrangements with thoseclients or if the firms provide tax services to certain members of management who serve in financial reporting oversightroles at an audit client, or to immediate family members of such persons.uditing: A Journal of Practice & Theory November 2008American Accounting Association

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34 Robinson

AAiminished auditor independence, but consistent with suggestions that information spillover fromhe provision of tax service enhances audit quality Simunic 1984; Panel on Audit Effectiveness000; Kinney et al. 2004.

PRIOR RESEARCHRegulators concern about the type of nonaudit services auditors provide for their audit clients

nd the magnitude of the fees they generate relative to audit services is based on the view thatuditor independence is vital to the production of high-quality audits, and that fees paid to auditorsor both audit and nonaudit services may impair such independence. The SEC-mandated feeisclosure data has generated numerous academic studies investigating the relation between audi-or independence and NAS for example, Frankel et al. 2002; Antle et al. 2002; Ashbaugh et al.003; Chung and Kallapur 2003; Francis and Ke 2003; Reynolds et al. 2004; Larcker andichardson 2004; Kinney et al. 2004. Overall, these studies do not find support for diminisheduditor independence from the provision of NAS.

DeFond et al. 2002 and Geiger and Rama 2003 utilize auditors going-concern opinions toore directly test the effects of NAS on auditor independence. Both these studies conclude that

onaudit fees have no adverse effect on auditors reporting judgments. In contrast to these studies,disaggregate nonaudit fees into a tax and a nontax component, recognizing that tax services mayave potentially different effects on audit quality since the review of the registrants tax returnsnd reserves require substantial knowledge about the audit client Sage and Sage 2005, 31.urther, my definition of audit failure is restricted to financially distressed firms that failed toeceive a going-concern qualification and subsequently filed for bankruptcy.

Prior research specifically examining the issue of auditor-provided tax services has focused onore indirect outcome measures such as firms propensity to restate previously filed financial

tatements Kinney et al. 2004 and firms reporting of income tax expense Gleason and Mills006. Kinney et al. 2004 document a negative association between tax service fees and restate-ents, and Gleason and Mills 2006 document that corporations that use their auditors to provide

ax services record lower IRS deficiency as additional tax expense. While this evidence suggestsome beneficial effect on firms financial and tax reporting quality from auditor-rovided tax services, there is no evidence, to date, that such information spillover fromuditor-provided tax services specifically improves the going-concern opinion. Given the negativeublic exposure auditors face when an audit client fails to receive a going-concern and subse-uently files for bankruptcy, as well as the regulatory initiatives afoot to restrict tax services byuditors, I examine the relation between auditor-provided tax services and the going-concernpinion among bankruptcy filing firms.

RESEARCH DESIGNample

I obtain an initial sample of 587 firms filing for Chapter 11 bankruptcy protection from Neweneration Inc.s Bankruptcy Datasource for the period 20012004. Compustat and detailed feeata requirements result in a final sample of 209 bankrupt firms153 firms that correctly receivedgoing-concern opinion prior to filing, and 56 firms that did not.

oing-Concern ModelTo investigate whether auditor independence measured by the going-concern audit opinion

s impaired by the presence of auditor-provided tax service I estimate the following logisticegression model:uditing: A Journal of Practice & Theory November 2008merican Accounting Association

wAuditor Independence and Auditor-Provided Tax Service: Evidence from Going-Concern Audit Opinions 35

AGCOPINION = 0 + 1RETURN + 2VOLATILITY + 3ZFCINDX + 4LEV + 5CHLEV

+ 6BIG5 + 7 logASSETS + 8SWORKCAP + 9INVEST + 10SOPCASH

+ 11ISSDEBT + 12ISSTOCK + 13DEBTRED + 14SELLOFF

+ 15RESTRUCT + 16OENEG + 17ROA + 18REPLAG1 + 19REPLAG2

+ 20DEFAULT + 2123FEE VARIABLES + 2426YEAR DUMMIES + 1

here:

GCOPINION an indicator variable equal to 1 if the firm received a going-concernopinion prior to the bankruptcy filing, and 0 otherwise;

RETURN the firms stock return over the last fiscal year prior to the filingdate;

VOLATILITY the variance in the firms stock returns over the last fiscal year priorto the filing date;

ZFCINDX the Zmijewski index measuring bankruptcy risk for the fiscal yearprior to the filing;

LEV total liabilities divided by total assets at the end of the fiscal yearprior to the filing;

CHLEV change in LEV over the last two reporting periods prior to the filing;BIG5 an indicator variable equal to 1 if the firm is audited by a Big 5

audit firm, and 0 otherwise;log(ASSETS) natural logarithm of total assets at the end of the fiscal year prior to

the filing;SWORKCAPworking capital current assets current liabilities divided by total

assets at the end of the fiscal year prior to the filing;INVEST the sum of cash and long- and short-term investment securities

scaled by total assets at the end of the fiscal year prior to the filing;SOPCASH operating cash flows divided by total assets at the end of the fiscal

year prior to the filing;ISSDEBT an indicator variable equal to 1 if the firm issues debt in the fiscal

year prior to the filing, and 0 otherwise;ISSTOCK an indicator variable equal to 1 if the firm issues equity in the fiscal

year prior to the filing, and 0 otherwise;DEBTRED an indicator variable equal to 1 if the firm reduces long-term debt in

the fiscal year prior to the filing, and 0 otherwise;SELLOFF an indicator variable equal to 1 if the firm sells assets in the fiscal

year prior to the filing, and 0 otherwise;RESTRUCT an indicator variable equal to 1 if the firm engages in restructuring

activities in the fiscal year prior to the filing, and 0 otherwise;OENEG an indicator variable equal to 1 if the firm has negative stockholders

equity at the end of the fiscal year prior to the filing, and 0otherwise;

ROA net income divided by total assets at the end of the fiscal year priorto the filing;

REPLAG1 number of days between the audit report filing date and thebankruptcy filing date;uditing: A Journal of Practice & Theory November 2008American Accounting Association

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36 Robinson

AAREPLAG2 number of days between the fiscal year end and the earningsannouncement date;

DEFAULT an indicator variable equal to 1 if the firm is in default on any of itsdebt in the year prior to filing, and 0 otherwise;

NONTAXRATIO the ratio of nontax NAS fees to total fees paid to the auditor;TAXRATIO the ratio of tax fees to total fees paid to the auditor;

log(AUDIT FEE) the natural logarithm of the sum of audit fees paid to the auditor;log(TAX FEE) the natural logarithm of the sum of tax fees paid to the auditor;

log(NONTAX NAS FEE) the natural logarithm of the sum of nontax nonaudit fees paid to theauditor; and

YEARDUMMIES indicator variable equal to 1 if the audit report is issued in each ofthe four sample years, and 0 otherwise.

The going-concern model utilized in the study is primarily based on the DeFond et al. 2002tudy, but relies on several other studies to motivate the use of additional explanatory variableshat are correlated with the going-concern opinion e.g., Mutchler et al. 1997; Reynolds andrancis 2000; Geiger and Rama 2003. Bankrupt firms generally have several years of poornancial performance prior to the bankruptcy filing; therefore I include several financial andarket derived variables in an attempt to capture the financial condition prevailing at the time of

he audit report that would create substantial doubt about the firms ability to continue as aoing-concern. The model includes RETURN and VOLATILITY, two market-based measures thateFond et al. 2002 find significantly correlated with the going-concern audit opinion. I expectnegative positive correlation between the going-concern opinion and RETURN and

VOLATILITY. To capture the probability of default, I use ZFCINDX, which is the financialondition index from Zmijewskis 1984 model. Higher values of ZFCINDX indicate a greaterikelihood of default, suggesting a positive relation between ZFCINDX and the issuance of aoing-concern opinion. I include LEV and CHLEV because firms with high and increasing lever-ge are more likely to be closer to debt covenant violations Beneish and Press 1993; Reynoldsnd Francis 2000; DeFond et al. 2002. Other measures attempt to capture cash flows, workingapital constraints, and earnings performance. SWORKCAP is working capital divided by totalssets and is expected to be negatively correlated with the going-concern opinion. DeFond et al.2002 find a negative correlation between SOPCASH cash flow from operating activities and theoing-concern opinion. I include two measures for earnings performance: ROA current earningserformance and OENEG a measure of long-term earnings performance. I expect a negativeorrelation between ROA and the likelihood of issuing a going-concern opinion, and positiveorrelation with OENEG. Like Ohlson 1980, I include OENEG, an indicator variable equal to 1f the firm has negative owners equity, to capture the persistence of the losses, as a firm is moreikely to report negative owners equity after several years of losses.

Consistent with Statement of Accounting Standards SAS No. 59, when auditors have sub-tantial doubt about the ability of an entity to continue as going-concern, they are required tovaluate the plans that management proposes to counteract the adverse circumstances. Behn et al.2001 document that auditors view various plans differently: plans to issue debt or equity areegatively correlated with a going-concern opinion, while plans to reduce spending or dispose ofssets are positively correlated with a going-concern opinion. Geiger and Rama 2003 find aositive correlation with cost reduction plans and asset sales and issuing a going-concern opinion.include five variables to capture the managerial actions that are potentially correlated with theoing-concern opinion. ISSDEBT and ISSTOCK are indicator variables equal to 1 if the firm issuesebt or equity respectively in the fiscal year prior to filing; DEBTRED is an indicatorariable equal to 1 if the firm reduces long-term debt and 0 otherwise; SELLOFF is anuditing: A Journal of Practice & Theory November 2008merican Accounting Association

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Andicator variable equal to 1 if the firm sells assets and 0 otherwise; RESTRUCT is an indicatorariable equal to 1 if the firm incurs any restructuring costs and 0 otherwise; and DEFAULT is anndicator variable equal to 1 if the firm is in default on any of its debt in the year prior to filing and

otherwise.Other variables in Equation 1 include log(ASSETS), BIG5, REPLAG1, and REPLAG2. Prior

esearch documents an inverse relation between the likelihood of issuing a going-concern opinionnd firm size Mutchler 1985; Hopwood et al. 1989; Chen and Church 1992; Carcello et al. 1995;eiger and Raghunandan 2001; Geiger and Rama 2003. Log(ASSET), the natural logarithm of

otal assets at the end of the fiscal year prior to filing, is the proxy measure for firm size. INVESTs the sum of cash and long- and short-term investment securities scaled by total assets. DeFond etl. 2002 include this as a measure of liquidity because firms with large cash and investmentecurities are more likely to weather adverse circumstances and potentially forestall bankruptcy.IG5 is also included as a control variable because DeFond et al. 2002 find a positive correlationetween being audited by a Big 5 auditor and receiving a going-concern opinion, consistent withotentially higher litigation costs influencing auditor reporting decisions. Additionally, Geiger andama 2006 investigate whether the type of auditor i.e., Big 4, national, or regional/local is

elated to the likelihood that the auditor will erroneously issue an unqualified opinion prior to theankruptcy filing of the client. They find that Big 4 firms are more likely to correctly issue aoing-concern opinion, consistent with providing a higher quality audit.

I include REPLAG1, the natural logarithm of the number of days from the audit report date tohe bankruptcy date, because Geiger et al. 2005 find a significant correlation between thisariable and the issuance of a going-concern opinion. REPLAG2, the natural logarithm of theumber of days between the fiscal year-end and the earnings announcement date, is includedecause prior research such as Carcello et al. 1995 and DeFond et al. 2002 find a significantssociation between audit opinion and longer reporting delays. Finally, I include year dummies forhe years covered over the sample period to allow for changes in auditor reporting behavior overhe period of the study because Geiger et al. 2005 document an increasing propensity by auditorso issue going-concern opinions after January 2002.

RESULTSescriptive Statistics

Panel A, Table 1 reports industry distribution for the sample. The data shows a wide industryistribution, although there is some evidence of industry clustering with three industrieslectronic, communications, and business servicestogether accounting for one-third of theample. Panel B documents that the probability of incorrectly issuing a clean audit opinion prioro a bankruptcy filing is decreasing over the sample period, from a high of 48 percent in 2001 to

low of 15 percent in 2004, suggesting an increasing propensity by auditors to issue going-oncern opinions, similar to Geiger et al. 2005.6 Panel C reports the distribution across auditears as well as the frequency of tax fee disclosures among sample firms. For the majority of theample firms the audit year predates the SEC requirement to disclose tax fees, which is reflectedn the infrequency with which tax fees are reported in the earlier period of the sample. As

The increasing propensity of auditors to issue GC opinions may reflect increased litigation risk. However, prior researchsuggests that litigation risk from auditor-provided NAS is relatively low Antle et al. 1997; Palmrose 2000; Anakwe2003. Anakwe 2003 analyzes legal filings against CPA firms for nonaudit work provided by CPA firms, and providesevidence specific to tax services. She reports that only 27 of the 143 cases related to filings against Big 5 auditors, andeight 30 percent of those cases involved tax work tax compliance, planning, and representation services. Those eightcases resulted in a total judgment of $4.5 million against Big 5 auditors.uditing: A Journal of Practice & Theory November 2008American Accounting Association

TABLE 1

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38 Robinson

AAIndustry, FilingYear, and Exchange Distribution of a Sample of209 Bankruptcy Filing Firms

153 Firms with Going-Concern Qualifications and 56 Firmswithout Going-Concern Qualifications Prior to Filing

anel A: Sample Distribution by Industry

IC Code IndustryGC

SampleNo GCSample Total

% ofTotal

3 Oil and gas exploration 2 2 4 1.96 Heavy construction 0 1 1 0.57 ConstructionSpecial 1 1 2 1.02 Textile mill products 0 1 1 0.53 Apparel 2 0 2 1.04 Lumber and wood products 1 0 1 0.55 Furniture and fixtures 2 0 2 1.06 Paper and allied products 1 0 1 0.58 Chemicals 6 3 9 4.39 Petroleum and coal products 1 0 1 0.50 Rubber and plastics products 2 0 2 1.02 Stone, clay, etc. products 2 0 2 1.03 Primary metals 10 2 12 5.74 Fabricated metal products 2 0 2 1.05 Machinery and computer 7 4 11 5.36 Electronic and electrical 16 7 23 11.07 Transportation equipment 7 0 7 3.38 Measuring equipment 4 0 4 1.92 Motor freight transport 2 1 3 1.44 Water transportation 1 1 2 1.05 Transportation by air 3 0 3 1.48 Communications 15 10 25 12.09 Utility services 7 2 9 4.30 WholesaleDurable 5 3 8 3.81 WholesaleNondurable 1 0 1 0.52 Building materials 1 1 2 1.04 Food stores 1 0 1 0.55 Automotive dealers 1 0 1 0.56 Apparel and accessory 3 1 4 1.97 Home furniture and equip 0 1 1 0.58 Eating and drinking places 4 1 5 2.49 Miscellaneous retail 3 1 4 1.9

(continued on next page)uditing: A Journal of Practice & Theory November 2008merican Accounting Association

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Axpected, the frequency of tax fee disclosure increases over the sample periodfrom 19.3 percentor audit years 20002001 to 54.7 percent over the 20022004 audit years.7

Table 2 reports descriptive statistics for the sample. The mean firm reports negative stock

The percentage of the bankrupt firms disclosing tax fees from 2000 to 2002 24 percent is lower than the 42 percentreported by Omer et al. 2006.

TABLE 1 (continued)

1 Non-depository credit institution 4 3 7 3.33 Insurance carriers 2 0 2 1.07 Holding, other investment 1 1 2 1.03 Business services 19 9 28 13.45 Automobile services 3 0 3 1.48 Motion pictures 1 0 1 0.59 Recreation services 1 0 1 0.50 Health services 4 0 4 1.93 Social services 1 0 1 0.57 Engineering services 3 0 3 1.49 Non-classifiable 1 0 1 0.5otal 153 56 209 100

anel B: Sample Distribution by Filing Year and Audit Opinion2001 % 2002 % 2003 % 2004 % Total %

C Concern 13 52 57 75 55 73 28 85 153 73o GC Concern 12 48 19 25 20 27 5 15 56 27otal 25 100 76 100 75 100 33 100 209 100

of total 12 36 36 16 100

anel C: Sample Distribution by Audit Year and Tax Fee Disclosure

Auditor Report

FrequencyTaxFees

Disclosed % Disclosing

GC NGC Total Yes No Total

udit Year 2000 46 20 66 4 62 6.12001 55 24 79 24 55 30.42002 34 10 44 18 26 40.92003 17 2 19 16 3 84.22004 1 0 1 1 0 100Total 153 56 209 63 146 30.1uditing: A Journal of Practice & Theory November 2008American Accounting Association

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AATABLE 2

Descriptive Statistics for the 209 Bankruptcy Filing Firms withAvailableAuditor Fee andCompustat Data for the FiscalYear Preceding the Bankruptcy Filings

ariables Mean Median Std. Dev. Maximum Minimum

ASRATIO 0.43 0.40 0.22 0.95 0.04ONTAXRATIO 0.37 0.34 0.25 0.95 0AXRATIO 0.06 0 0.12 0.66 0otal Fees$thousands

1,333 492 2,305 16,300 26.75

udit Fees$thousands

529 265 991 11,900 17.5

onaudit Fee$thousands

750 151 1,640 11,960 0

ontax NAS Fees$thousands

732 120 1657 11,960 0

ax Fees$thousands

72 0 244 1,927 0

FCINDX 3.47 1.24 7.40 47.25 2.84SSET $million 1,110 181 2,777 19,415 2.14ETURN 0.36 0.37 0.38 2.06 0.98OLATILITY 1.78 0.53 2.88 10.00 0.04EV 0.69 0.69 0.35 2.17 0.10HLEV 0.22 0.11 0.45 2.27 0.46OA 0.43 0.24 0.75 0.28 4.83ENEG 0.27 0 0.45 1.00 0WORKCAP 0.12 0.04 0.69 0.88 4.07OPCASH 0.21 0.03 0.63 0.79 5.42NVEST 0.16 0.06 0.22 1.00 0SSDEBT 0.59 1.00 0.49 1.00 0SSTOCK 0.65 1.00 0.48 1.00 0ELLOFF 0.38 0 0.49 1.00 0EBTRED 0.87 1.00 0.34 1.00 0ESTRUCT 0.22 0 0.42 1.00 0EPLAG1 279 267 154 672 14EPLAG2 48 45 24 163 15COPINION 0.73 1.00 0.44 1.00 0IG5 0.85 1.00 0.36 1.00 0EFAULT 0.31 0 0.46 1.00 0

Variable Definitions:NASRATIO the ratio of total NAS fees to total fees paid to the auditor;

NONTAXRATIO the ratio of nontax NAS fees to total fees paid to the auditor;TAXRATIO the ratio of tax service fees to total fees paid to the auditor;Total Fees the sum of audit and nonaudit fees paid to the auditor;

(continued on next page)uditing: A Journal of Practice & Theory November 2008merican Accounting Association

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Aeturns, return on assets, negative working capital, and negative operating cash flows.8 The meannd median sample firm is highly leveraged and relatively small compared to the Compustatopulation, with mean median assets totaling $1.1 billion $181 million.9 The average samplerm was audited by a Big 5 auditor. Many firms took managerial actions prior to the bankruptcyling such as issuing new equity and/or debt, selling assets, restructuring activities, and reducing

ong-term debt. Table 2 also reports that the mean and median values of nonaudit services to totalees NASRATIO are 0.43 and 0.40, respectively. The total fees paid to firm auditors ranged from27,000 to $16.3 million. Tax advisory service fees, on average, account for 6 percent of total fees

I examine whether the sample firms exhibited signs of financial distress as defined in Hopwood et al. 1994; that is,whether the firms had at least one of the following: 1 negative working capital in the current year, 2 a loss fromoperations in any of the three years prior to bankruptcy, 3 a retained earnings deficit in year minus three, or 4 abottom-line loss in any of the last three years before bankruptcy. Only four of the sample firms failed to meet theHopwood et al. 1994 definition of financial stress. The results are unchanged when these firms are deleted.The mean median firm in the Compustat population has total assets of $5.5 billion $183.8 million over the sampleperiod.

TABLE 2 (continued)Audit Fees the fees paid to the auditor for audit services;

Nonaudit Fees the fees paid to the auditor for all NAS;Nontax Fees the fees paid to the auditor for all NAS other than tax service;

Tax Fees the fees paid to the auditor for tax advisory services;ZFCINDX the Zmijewski index measuring bankruptcy risk for the fiscal year prior to filing;

ASSET total assets at the end of the fiscal year prior to filing;RETURN the firms stock returns over the last fiscal year prior to the filing;

VOLATILITY the variance of stock returns over the year prior to the filing;LEV total liabilities divided by total assets at the end of the fiscal year prior to the filing;

CHLEV change in LEV over the last two reporting periods preceding filing;ROA net income divided by total assets at the end of the fiscal year prior to the filing;

OENEG an indicator variable equal to 1 if the firm has negative stockholders equity at the end of the fiscalyear prior to the filing, and 0 otherwise;

SWORKCAP working capital current assetscurrent liabilities divided by total assets at the end of the fiscal yearprior to the filing;

SOPCASH operating cash flows divided by total assets at the end of the fiscal year prior to the filing;INVEST the sum of cash and long- and short-term investment securities scaled by total assets at the end of

the fiscal year prior to the filing;ISSDEBT an indicator variable equal to 1 if the firm issues debt in the fiscal year prior to the filing, and 0

otherwise;ISSTOCK an indicator variable equal to 1 if the firm issues equity in the fiscal year prior to the filing, and 0

otherwise;SELLOFF an indicator variable equal to 1 if the firm sells assets in the fiscal year prior to the filing, and 0

otherwise;DEBTRED an indicator variable equal to 1 if the firm reduces long-term debt in the fiscal year prior to the

filing, and 0 otherwise;RESTRUCT an indicator variable equal to 1 if the firm has restructuring activities in the fiscal year prior to the

filing, and 0 otherwise;REPLAG1 number of days between the audit filing date and the bankruptcy filing date;REPLAG2 number of days between the fiscal year end and the earnings announcement date;

GCOPINION an indicator variable equal to 1 if the firm received a going-concern opinion prior to the bankruptcyfiling, and 0 otherwise;

BIG5 an indicator variable equal to 1 if the firm is audited by a Big 5 audit firm, and 0 otherwise; andDEFAULT an indicator variable equal to 1 if the firm is in default on any of its debt in the year prior to filing,

and 0 otherwise.uditing: A Journal of Practice & Theory November 2008American Accounting Association

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AAhile nontax NAS fees account for an average of 37 percent of total fees paid to the auditor.hese nontax service fees include: information technology systems fees up to 2002, audit-related

ees, and a category simply defined as other fees. There is significant variation in the amount ofonaudit fees paid to the incumbent auditor, ranging from a minimum of $0 to a maximum oflmost $12 million.

Table 3 compares sample variables between the bankrupt filing firms that correctly received aoing-concern opinion prior to the filing GC and those that did not NGC. I focus on differencesn median values as the means are more affected by outliers. Table 3 documents that the GC firmsre more likely to have negative stockholders equity, lower working capital, and are more lever-ged than the NGC firms. The two sub-samples have similar bankruptcy risk, stock and accountingerformance, and are of similar size. With respect to fee data, the GC sample reports significantlyigher audit fees and tax service fees than the NGC firms.

ultivariate Test ResultsTable 4 reports the results from the estimation of Equation 1. The results reported for Model

in the table reflect the estimation of Equation 1 without the inclusion of any fee variable andeport a model R2 of 41.7 percent, implying that the model has fairly good explanatory power.imilar to DeFond et al. 2002, I document a positive correlation between a going-concernpinion and volatility and leverage, but no correlation between changes in leverage and operatingash flows. I also find that firms with higher working capital and stock performance prior to theling are less likely to receive a going-concern opinion. However, going-concern opinions areore likely if the firm engages in restructuring activities prior to filing. These results suggest thatanagerial actions are important control variables.11

Models 24 reflect the estimation of Equation 1 with fee variables included. The pseudo-R2s essentially unchanged when the audit fee and grossed-up nonaudit fee variables are added to theegression see Model 2. I find no significant correlation between either the audit fee or theonaudit fee variables and the probability of issuing a going-concern opinion. Model 3 reports theesults when nonaudit fee is decomposed into two components: the ratio of total nontax NAS feeso total fees, and a ratio for tax fees to total fees. Model 4 reports the regression results with logf tax fees and log of the nontax nonaudit fees as explanatory variables. Both models showignificant improvement over the base model Model 1. For example, the pseudo-R2 for Model 3s 10.6 percent higher than for Model 1 46.1 41.7 and the pseudo-R2 for Model 4 is 18.2ercent higher than Model 1 49.3 41.7. More importantly, both models report a significant andositive correlation between the tax fee variable and the going-concern opinion. The resultsuggest that auditors are more likely to correctly issue going-concern opinions prior to bankruptcylings if they also provide tax services for their clients. Nontax NAS services fees are not signifi-antly correlated with the going-concern opinion.

ontrolling for Expected Fees and EndogeneityDeFond et al. 2002, 1264 argue that auditor independence may be influenced by the

mount of client fees relative to their expected amounts, rather than the nominal amounts. I

0 The mean median tax fees of $72,000 0 is smaller relative to a mean median of $178,000 0 for the Compustatpopulation over the sample period, suggesting that the average sample firm paid lower tax fees relative to the averageCompustat firm.

1 The ISSDEBT variable has the opposite sign from that predicted from prior research. One explanation for this result isthat instead of being a mitigating factor in the auditors decision to issue a going-concern qualification, the need to seeknew financing may actually be a confirmatory factor. This may be particularly valid for this sample of firms, given thatthe average stressed firm is already likely to be highly leveraged.uditing: A Journal of Practice & Theory November 2008merican Accounting Association

TABLE 3

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AComparison of Going-Concern Opinion Sample of 153 Bankruptcy Filing Firms withNon-Going-Concern Opinion Sample of 56 Bankruptcy Filing Firms

Mean Median

GCSamplen = 153

No GCSamplen = 56

2-SampleTest

Two-Tailedp-value

GCSamplen = 153

No GCSamplen = 56

Wilcoxon2-Sample

TestTwo-Tailed

p-value

ASRATIO 0.419 0.454 0.344 0.389 0.415 0.3420.000 0.000 0.000 0.000

ONTAXRATIO 0.348 0.425 0.058* 0.309 0.409 0.052*0.000 0.000 0.000 0.000

AXRATIO 0.072 0.029 0.016** 0.000 0.000 0.002***0.000 0.043 0.000 0.000

otal Fees 1429.76 1069.54 0.235 515.000 382.921 0.2980.000 0.000 0.000 0.000

udit Fees 599.244 337.052 0.014** 283.500 226.500 0.077*0.000 0.000 0.000 0.000

onaudit Fees 830.520 732.492 0.684 180.850 141.806 0.7440.000 0.000 0.000 0.000

ontax 740.755 708.566 0.893 128.000 101.372 0.837NAS Fees 0.000 0.000 0.000 0.000

ax Fees 89.765 23.926 0.014** 0.000 0.000 0.002***0.000 0.095 0.000 0.031

FCINDEX 3.470 3.477 0.996 1.320 0.618 0.1400.000 0.008 0.000 0.000

SSET 1351.1 452.5 0.001*** 193.7 153.6 0.1320.000 0.000 0.000 0.000

ETURN 0.388 0.262 0.089* 0.395 0.353 0.1780.000 0.000 0.000 0.000

OLATILITY 1.962 1.293 0.055* 0.527 0.542 0.4110.000 0.000 0.000 0.000

EV 0.740 0.535 0.000*** 0.746 0.558 0.000***0.000 0.000 0.000 0.000

HLEV 0.236 0.191 0.519 0.118 0.112 0.4360.000 0.002 0.000 0.000

ENEG 0.320 0.143 0.004*** 0.000 0.000 0.012**0.000 0.004 0.000 0.008

OA 0.399 0.526 0.363 0.244 0.232 0.6710.000 0.000 0.000 0.000

WORKCAP 0.208 0.118 0.000*** 0.002 0.098 0.000***

(continued on next page)uditing: A Journal of Practice & Theory November 2008American Accounting Association

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AAherefore estimate separate fee determination regressions models for audit fees, nonaudit fees, taxees, nontax NAS fees, and the various fee ratios, relying on the models used in DeFond et al.2002, but augment the tax fee determination model with three additional variables that poten-ially influence the demand for tax servicesthe size of the operating loss carryforwards, and the

TABLE 3 (continued)

Mean Median

GCSamplen = 153

No GCSamplen = 56

2-SampleTest

Two-Tailedp-value

GCSamplen = 153

No GCSamplen = 56

Wilcoxon2-Sample

TestTwo-Tailed

p-value

0.000 0.032 0.110 0.000OPCASH 0.162 0.345 0.160 0.015 0.076 0.042**

0.000 0.007 0.000 0.000NVEST 0.140 0.223 0.034** 0.048 0.138 0.028**

0.000 0.000 0.000 0.000SSTOCK 0.627 0.696 0.349 1.000 1.000 0.359

0.000 0.000 0.000 0.000SSDEBT 0.667 0.393 0.000*** 1.000 0.000 0.000***

0.000 0.000 0.000 0.000ELLOFF 0.340 0.500 0.041** 0.000 0.500 0.037**

0.000 0.000 0.000 0.000EBTRED 0.902 0.786 0.058* 1.000 1.000 0.028**

0.000 0.000 0.000 0.000ESTRUCT 0.261 0.089 0.001*** 0.000 0.000 0.008***

0.000 0.024 0.000 0.063EPLAG1 293.51 238.04 0.008** 278.00 243.50 0.040**

0.000 0.000 0.000 0.000EPLAG2 50.29 43.52 0.022** 45.000 45.00 0.133

0.000 0.000 0.000 0.000IG5 0.850 0.857 0.893 1.000 1.000 0.895

0.000 0.000 0.000 0.000EFAULT 0.346 0.214 0.053* 0.000 0.000 0.033**

0.000 0.000 0.000 0.000

ariables are as defined in Table 2. *, **, and *** indicate that the difference between the going-concern and theo-going concern samples is significant at the 10%, 5%, and 1% levels in two-tail tests. The tests for mean differences areased on the t-test assuming unequal variances and the tests for median differences are based on the Wilcoxon two-sampleest.uditing: A Journal of Practice & Theory November 2008merican Accounting Association

TABLE 4

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AThe Relation between Going-ConcernAudit Opinions for a Sample of 209 Bankruptcy FilingFirms andAuditor FeeVariables

xplanatory VariablesPredicted

Sign

Model 1Coefficient(p-value)




ETURN / 0.985 0.992 1.117 1.0130.06 0.07 0.05 0.08

OLATILITY 0.166 0.170 0.213 0.2350.09 0.06 0.03 0.02

FCINDX 0.047 0.038 0.048 0.0390.58 0.67 0.62 0.70

EV 1.668 1.602 1.427 1.5720.09 0.11 0.15 0.12

HLEV 0.929 1.098 1.388 1.8690.49 0.43 0.37 0.26

IG5 0.184 0.154 0.270 0.3430.77 0.81 0.67 0.60

og(ASSET) 0.000 0.057 0.045 0.0410.99 0.78 0.77 0.84

WORKCAP 1.384 1.425 1.872 2.1100.02 0.02 0.00 0.00

OPCASH 0.227 0.299 0.579 0.5600.73 0.66 0.40 0.44

NVEST 0.695 0.653 1.175 0.8890.51 0.54 0.30 0.45

SSDEBT 0.942 0.891 0.890 0.8890.04 0.06 0.06 0.07

SSTOCK 0.227 0.293 0.245 0.1880.62 0.54 0.61 0.71

EBTRED 0.247 0.178 0.262 0.3170.67 0.77 0.67 0.60

ELLOFF 0.950 0.997 1.190 1.3040.98 0.98 0.99 0.99

ESTRUCT 1.620 1.518 1.929 1.7950.01 0.02 0.00 0.00

ENEG 0.734 0.720 0.924 0.9420.34 0.35 0.24 0.25

OA 0.126 0.158 0.114 0.1510.71 0.65 0.76 0.69

EPLAG1 0.790 0.837 0.901 0.9820.98 0.98 0.99 0.99


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AAevel and change in the valuation allowance account.12 Using the residuals from the above modelstimations to proxy for the unexpected fee variables, I re-estimate Equation 1 inserting thenexpected fee variables for the nominal fee variables. The results in Table 5 with the unexpectedee variables as explanatory variables are almost identical to those reported in Table 4.

The empirical findings documented so far may be potentially misspecified because the going-oncern opinion, audit fees, and nonaudit fees are endogenously determined. Prior researchWhisenant et al. 2003; DeFond et al. 2002; Geiger and Rama 2003 document that nonaudit and

2 DeFond et al. 2002 rely heavily on other research in developing these models. For example: Craswell et al. 1995;Whisenant et al. 2003; Firth 1997; Parkash and Venable 1993; Frankel et al. 2002. The inclusion of these additionalvariables increased the explanatory power of the model by 11 percent.

TABLE 4 (continued)


Sign





EPLAG2 0.731 0.660 0.611 0.6270.17 0.22 0.27 0.30

EFAULT 0.761 0.694 0.887 0.9440.16 0.21 0.12 0.12

ONTAXRATIO / 1.1290.33

AXRATIO / 5.1710.05

og(Audit Fees) / 0.377 0.2770.34 0.85

og(Nonaudit Fees) / 0.1230.59

og(Tax Fees) / 0.1780.00

og(Nontax Fees) / 0.1040.41

ax-Rescaled R2 41.7% 42.2% 46.1% 49.3%ercent 84.7 84.9 86.4 87.6Concordant

Variable Definitions:NONTAXRATIO the ratio of nontax NAS fees to total fees paid to the auditor;

TAXRATIO the ratio of tax service fees to total fees paid to the auditor;Log(Audit Fees) the natural logarithm of the sum of audit fees paid to the auditor;

Log(Nonaudit Fees) the natural logarithm of the sum of nonaudit fees paid to the auditor;Log(Tax Fees) the natural logarithm of the sum of tax fees paid to the auditor; and

Log(Nontax Fees) the natural logarithm of the sum of NAS service fees minus tax fees paid to the auditor.

ll other variables are as defined in Table 2.uditing: A Journal of Practice & Theory November 2008merican Accounting Association

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AGoing-Concern Opinion Models for a Sample of 209 Bankruptcy Filing Firms withUnexpected FeeVariables Included as Independent Variables


Sign





ETURN / 0.985 0.988 1.228 1.1820.06 0.06 0.03 0.04

OLATILITY 0.166 0.170 0.200 0.2300.09 0.06 0.04 0.02

FCINDX 0.047 0.042 0.061 0.0350.58 0.63 0.52 0.70

EV 1.668 1.677 1.676 1.7410.09 0.09 0.10 0.08

HLEV 0.929 0.994 1.092 1.6560.49 0.47 0.47 0.28

IG5 0.184 0.156 0.095 0.0440.77 0.81 0.88 0.95

og (ASSET) 0.000 0.006 0.036 0.0470.99 0.97 0.80 0.75

WORKCAP 1.384 1.407 1.806 1.9350.02 0.02 0.00 0.00

OPCASH 0.227 0.265 0.081 0.1380.73 0.69 0.91 0.84

NVEST 0.695 0.647 1.177 0.9360.51 0.54 0.29 0.41

SSDEBT 0.942 0.912 0.854 0.8280.04 0.05 0.08 0.09

SSTOCK 0.227 0.253 0.247 0.1910.62 0.59 0.60 0.69

EBTRED 0.247 0.209 0.415 0.4180.67 0.73 0.49 0.49

ELLOFF ? 0.950 0.997 1.203 1.2910.98 0.98 0.99 0.99

ESTRUCT 1.620 1.547 1.754 1.7340.01 0.02 0.00 0.01

ENEG 0.734 0.713 1.014 0.9590.34 0.35 0.21 0.26

OA 0.126 0.120 0.024 0.0090.71 0.73 0.95 0.98

EPLAG1 0.790 0.815 0.964 1.0430.98 0.98 0.99 0.99


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AAudit fees are jointly determined. To address this issue, I utilize a two-stage procedure recom-ended by Nelson and Olsen 1978 and used by DeFond et al. 2002. Table 6 reports the results

rom the second-stage structural regression of the going-concern opinion. In the model withrossed-up nonaudit fees, I document a marginally significant and positive correlation with auditee and the going-concern opinion and no significant correlation with nonaudit fees. In the modelith nonaudit fees decomposed into the tax and nontax components, I again document a positive

nd significant coefficient on the tax fee variable, a positive and marginally significant coefficientn the audit fee variable, and an insignificant coefficient on the nontax nonaudit fee variable.

TABLE 5 (continued)


Sign





EPLAG2 0.731 0.724 0.627 0.7100.17 0.18 0.27 0.23

EFAULT 0.761 0.720 1.074 1.1110.16 0.19 0.07 0.07

E / 0.3720.75

ONTAXRATIO / 7.875UE TAXRATIO 0.01E Log(Audit Fees) / 0.265 0.223

0.50 0.58E Log(Nonaudit Fees) / 0.039

0.86E Log(Tax Fees) / 0.181

0.00E Log(Nontax Fees) / 0.158

0.28ax-Rescaled R2 41.7% 41.9% 47.0% 49.5%

ercent 84.7 84.8 87.0 87.7Concordant

Variable Definitions:UE NONTAXRATIO residual from the applicable fee determination model;

UE TAXRATIO residual from the applicable fee determination model;UE Log(Audit Fees) residual from the applicable fee determination model;

UE Log(Nonaudit fees) residual from the applicable fee determination model;UE Log(Tax Fees) residual from the applicable fee determination model;

UE Log(Nontax fees) residual from the applicable fee determination model.

ll other variables are as defined in Table 2.uditing: A Journal of Practice & Theory November 2008merican Accounting Association

TABLE 6

Structural Model fromTwo-Stage Procedure (after controlling for endogeneity) for a Sampleof 209 Bankruptcy Filing Firms from 2001-2004

Dependent Variable = GCOPINION Dependent Variable = GCOPINION

RVZLCBLSSIIIDSRORRRDAN

CfMP

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AETURN 1.007 0.09 RETURN 0.814 0.28OLATILITY 0.151 0.11 VOLATILITY 0.254 0.03FCINDX 0.061 0.54 ZFCINDX 0.074 0.53EV 1.531 0.13 LEV 0.514 0.67HLEV 1.018 0.49 CHLEV 3.914 0.05IG5 0.154 0.82 BIG5 2.360 0.98og (ASSET) 0.220 0.52 Log (ASSET) 1.143 0.05WORKCAP 1.431 0.02 SWORKCAP 3.620 0.00OPCASH 0.246 0.71 SOPCASH 3.111 0.00NVEST 0.965 0.37 INVEST 1.859 0.27SSDEBT 1.005 0.04 ISSDEBT 0.863 0.16SSTOCK 0.200 0.53 ISSTOCK 0.458 0.47EBTRED 0.383 0.56 DEBTRED 0.299 0.71ELLOFF 0.891 0.04 SELLOFF 1.666 0.00ESTRUCT 1.525 0.02 RESTRUCT 2.485 0.00ENEG 0.862 0.21 OENEG 1.188 0.22OA 0.285 0.33 ROA 0.656 0.28EPLAG1 0.709 0.95 REPLAG1 0.982 0.97EPLAG2 0.495 0.43 REPLAG2 0.457 0.57EFAULT 0.770 0.21 DEFAULT 0.081 0.92UDHAT 1.403 0.08 AUDHAT 2.342 0.07ONHAT 0.552 0.25 TAXHAT 1.169 0.00

NONTAXHAT 0.196 0.42hi-squared for model 25 degrees of

reedom 73.810 p = 0.0001ax-rescaled R2 0.433

Chi-squared for model 26 degrees offreedom 127.061 p = 0.0001Max-rescaled R2 0.663

ercent Concordant 85.6 Percent Concordant 93.3

Variable Definitions:AUDHAT predicted value of audit fee;NONHAT predicted value of nonaudit fee;TAXHAT predicted value of tax service fee component of nonaudit fee;

NONTAXHAT predicted value of nontax service fee component of nonaudit fee.

ll other variables are as described in Table 2. The models include year dummy variables estimates not reported.p-values are reported in parentheses.uditing: A Journal of Practice & Theory November 2008American Accounting Association

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AAhese results suggest that the earlier finding from Tables 4 and 5, which document that auditorndependence is enhanced by tax work, is not affected by endogeneity. In fact, controlling for theoint determination in audit and nonaudit fees improves the explanatory power of the model.13

obustness Checksonservatism versus Accuracy

The positive relation between the tax fee variable and the going-concern opinion is consistentith information spillover. However, an alternative explanation for the positive relation is that the

oint provision of audit and tax services induces auditors to make more conservative decisions.his implies that auditors would be more likely to give qualified reports even when they arenwarranted. To rule out this alternative explanation, I re-estimate Equation 1 using a matchedample of nonbankrupt firms from the Compustat population.14 I find no evidence that conserva-ism is driving the result reported in the study. Specifically, the coefficient on the tax fee variablehile positive is insignificant 0.062, p = 0.216 in a two-tailed test. While the positive coefficient

s consistent with some conservatism effects, a comparison of the coefficients on the tax variableetween the two samples suggests that this is not likely what is driving the results in the bank-uptcy setting. The coefficient is much smaller than that in the bankrupt sample 0.062 comparedo 0.178.

irst-Time Going-Concern OpinionsPrior studies suggest that issuing a first-time going-concern opinion may be more difficult for

n auditor relative to issuing a modified opinion in subsequent periods, and as such, may requiredifferent decision model Kida 1980; Mutchler 1984; Geiger et al. 1998; Carcello and Neal

003; Geiger and Rama 2003. Accordingly, I re-estimate Equation 1 but restrict the going-oncern firms to those firms with first-time going-concern opinions. The restricted sample of 181rms includes 125 first-time going-concern opinions and the 56 firms that had unqualified opin-

ons. The results are robust to this alternative specification. The regression pseudo-R2 increased to.567, which suggests that the model performance improved with the first-time going-concernestriction. The coefficient on the tax fee variable is 0.236 and is highly significant. The coeffi-ients on the other two fee variables are insignificant at conventional levels.

andatory Tax Fee DisclosureThe SEC requirement to separately disclose the tax fee components of nonaudit fees only

ecame mandatory in 2003.15 While the SEC encouraged issuers to adopt the disclosure provisionsarlier, the disclosure of tax service fees was voluntary prior to the 2002 audit year. Omer et al.2006 provide evidence that many firms did not disclose tax fees prior to the SEC requirement

3 I also test whether the going-concern opinion, audit fee, and nonaudit fee are endogenous. I find no evidence based onthe Hausman 1978 test that the going-concern opinion is jointly determined with audit and nonaudit fees for thissample of bankrupt firms.

4 To ensure that the matched firms include some going-concern opinions since the dependent variable is the going-concern opinion, I match based on size asset, probability of bankruptcy Zmijewski index and firm performanceROA in the year prior to the bankruptcy filing. The matched firms are not significantly different from the sample firmsin size, probability of bankruptcy, profitability, level of debt, tax fees, and audit fees. However, the matched firms havehigher ratios of tax fees to total fees and audit to total fees. Sixty-nine matched firms received going-concern opinionsin the audit report prior to the filing year.

5 The new disclosure requirements were effective for periodic annual filings and proxy or financial statement filings forthe first fiscal year ending after December 15, 2003. Thus, the new disclosure requirements were not mandatory until thecalendar-year 2003 periodic annual filings were made in 2004. Companies were required to disclose fees paid to theprincipal auditor in four categories for the two most recent years.uditing: A Journal of Practice & Theory November 2008merican Accounting Association

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Aonly 42 percent of their sample of 5,727 firm years from 2000 to 2002 disclosed tax fees. Theack of disclosure potentially introduces noise in the tax fee variable, since a zero tax fee reportedrior to the SEC requirement may be actually nonzero but not disclosed. This would seem to biasgainst finding any significance on the tax fee variable. To mitigate this potential problem,re-estimate Equation 1 but restrict the sample to audit years after the SEC requirement

20022004 audit years.17 The results are qualitatively unchanged coefficient on the tax feeariable is 0.227, p = 0.035 based on one-tailed test. I also re-estimate the model using a samplehat includes firms that voluntarily reported tax fees prior to the SEC requirement 20002001udit years in addition to the post-SEC sample. The coefficient on the tax fee variable is 0.346nd is significant at the 1 percent level. The coefficients on the other two fee variables arensignificant at conventional levels.18

nfluential ObservationsTo determine whether the results are driven by a few sample firms with large tax service fees,

delete those firms with tax fees above the mean of $72,000.19 The results are qualitativelynchanged when these firms are excluded from the sample. I also perform a more rigorous test forutliers suggested by Belsley et al. 1980 and deleted eight firms with residuals which suggesthat these are potentially influential observations. The results are qualitatively unchanged whenhese firms are excluded from the sample. In fact, both the audit and tax fee variables are positivend significant in the re-estimated models.

ther FeesFinally, I decompose nonaudit fees into all of its componentsnamely audit-related tax

ervice fees, information systems design fees, and a category listed as other. I find no significantffect for any of the other NAS fee components, and more importantly report the positive andignificant result for the tax service fee component only.

SUMMARYThis study examines whether auditor independence is impaired through the provision of tax

ervices by focusing on auditors issuance of going-concern opinions among a sample ofankruptcy-filing firms. The evidence from the bankruptcy setting is important to the continuingebate on auditor independence because the bankruptcies of several large corporations such asnron brought the issue to center stage and motivated several provisions of the Sarbanes-Oxleyct of 2002. SOX severely restricted many types of nonaudit services audit firms could provide to

heir clients while allowing some tax services, suggesting some beneficial effect from auditor-rovided tax services.

I document a significant and positive relation between the likelihood of correctly issuing aoing-concern opinion in the last audit report prior to the bankruptcy filing and the level of taxervices fees. I find no significant correlation with the going-concern opinion and either audit fees

6 Mishra et al. 2005 find evidence of higher tax to audit fee ratios after the SEC requirement, consistent with higher taxfees being reported.

7 Restricting the sample to audit years after mandatory disclosure 64 observations and estimating the regression with thefull set of explanatory variables led to failure of the logistic regression to converge. The results I report above are basedon the 64 firms, but the model only includes those explanatory variables that are significant at least at the 10 percentlevel, in addition to the fee variables.

8 Including the 28 pre-SEC voluntary disclosers increases the sample size to 92 observations. I also examine whether theresults are sensitive to any potential confusion about how to disaggregate total fees into the audit and other componentsin the year after the SEC requirement. I re-estimate the regression after deleting observations for the 2000 audit year thefirst year that firms were required to publicly report disaggregated fees. The results are qualitatively unchanged.

9 Thirty-two firms fall in this category, 28 of which received a going-concern opinion.uditing: A Journal of Practice & Theory November 2008American Accounting Association

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AAr the nontax component of NAS fees. This result holds after controlling for unexpected fees,ndogeneity among the fee variables, and various robustness checks. This result is inconsistentith diminished auditor independence, but rather suggests that audit quality is enhanced through

nformation spillover from auditor-provided tax services. The results of the study contribute to theurrent debate on auditor independence and NAS by providing evidence that the level of taxervice fees does not appear to systematically impair auditor independence in failing firms.

REFERENCESnakwe, B. 2003. An examination of the factors associated with lawsuits against accountants for nonaudit

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