Audit effort, audit fees, and the provision of nonaudit services to audit clients

SYNOPSIS AND INTRODUCTION: In this article, we use audit-hour and billing-rate data supplied by a large public accounting firm to address the question, Does providing audit clients with nonaudit services result in knowledge spillovers and audit production efficiencies that could produce economic rents for the auditor? In prior analytical work, both Simunic (1984) and Beck et al. (1988) have argued that knowledge acquired while providing nonaudit services may spill over to the production of the audit, and thus generate production efficiencies. If audit production efficiencies lead to cost savings that are retained in whole or in part by the auditor (rather than passed on to the client), then economic rents accrue to the auditor, creating incentives for the auditor to resolve disputes in the client's favor. Although several past studies suggest that the joint provision of audit and nonaudit services may give rise to knowledge spillovers that could lead to economic rents (Palmrose 1986; Simon 1985; Simunic 1984; Turpen 1990), they do not provide direct evidence that spillovers or rents exist, and the empirical results are mixed. For example, Abdel-khalik (1990, 320) reports that he was unable to detect interdependencies between audit and nonaudit fees, a direct contrast to the findings of Simunic and Palmrose. Further, Palmrose reports a positive relation between audit fees and the nonaudit fees paid to nonincumbent firms, a finding that weakens the argu-