Study: Fees, auditor freedom not linked

Gary Gentile

Monday, Jan. 28, 2002 | 9:45 a.m.

LOS ANGELES -- A study of company proxy statements is challenging the notion that accounting firms that earn consulting fees from companies they audit have a built-in conflict of interest.

In the wake of the collapse of Enron Corp., some members of Congress and shareholder activism groups have called for strict rules preventing auditors from providing lucrative non-audit services.

But a study of nearly 1,000 public companies to be released today concludes there is no correlation between consulting fees and the willingness of auditors to deliver bad news to their employers.

Mark DeFond and K.R. Subramanyam of the University of Southern California's Leventhal School of Accounting looked at one particular piece of bad news -- a statement from auditors that a company is not likely to survive as a going concern for one year beyond the date of their financial statement.

The researchers culled proxy statements to shareholders filed in 2001 by more than 3,000 companies. Last year was the first in which companies were required by the Securities and Exchange Commission to disclose how much they paid accounting firms for audits and how much was paid for other services, including tax preparation and advice on mergers and acquisitions.

Some shareholders contend that the disclosure rules do not go far enough to protect investors and employee pension plans.

Union pension funds representing about $220 billion in assets have launched a nationwide campaign to put the issue on the agenda at shareholder meetings this year. The pension funds want to bar accounting firms from doing both auditing and consulting for the same company.

The researchers narrowed their list to 944 companies in financial distress -- the ones most likely to receive a so-called "going concern" opinion from an auditor.

They found no significant association between the ratio of audit to non-audit fees and the likelihood of an auditor issuing a going concern opinion.

"Non-audit service that people are concerned about don't seem to influence those decisions," DeFond said.

The pair also wanted to know if accounting firms that receive particularly large fees for audits alone were less likely to deliver bad news. They found just the opposite, that auditors are more likely to issue going concern opinions to clients who pay relatively higher fees.

The researchers concluded that fear of being sued and the loss of professional credibility made audit firms more conservative and provided "incentives for auditor independence that outweigh the economic dependency created by higher fees."

The researchers said that because their study focused only on one piece of financial information, it does not take into account the broader range of issues raised by the Enron case. It also does not examine whether highly paid auditors might be influenced to allow companies to inflate or even misstate earnings.

The two said their study offers one interpretation of data and should not be relied on to make policy. Similarly, they said, regulators and Congress should not be influenced by the Enron mess when setting rules.

"We're not policy-makers," said Subramanyam. "Our study gets away from emotionally reacting to one particular example. There are 10,000 public companies in this country and one Enron."