Dual‐Class Equity Structure, Nonaudit Fees and the Information Content of Earnings

• DOI: http://doi.org/10.1111/j.1467-8683.2008.00665.x
• Published date: 01 March 2008
• Date: 01 March 2008
• Author: Flora Niu

Dual-Class Equity Structure, Nonaudit Fees and

the Information Content of Earnings

Flora Niu*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper examines the relationship between dual-class share structure and the purchase of

nonaudit services, and the extent to which the market’s valuation of accounting information is inf‌luenced by the perception

of auditing compromise resulting from such purchases.

Research Findings/Results: Using a sample of Canadian companies from 2003–2004, we f‌ind that dual-class f‌irms pay a

larger amount of nonauditfees to the auditors, relative to single-class f‌irms, both in the absolute dollar amount and as a ratio

of total audit fees. In addition, the returns-earnings association is signif‌icantly lower for dual-class f‌irms than for their

counterparts, and there is a further valuation discount as dual-class f‌irms increase nonaudit service purchases.

Theoretical Implications: We argue that severe agency problems inherent from the deviation from the one-vote-per-share

structure lead to greater demand for economic bonding with the auditors via the purchase of nonaudit services. This study

contributes to the growing body of nonaudit service literature by documenting the empirical link between ownership of

control and nonaudit purchases.

Practical Implications: The results indicate that investors believe a larger amount of nonaudit services highlights the

underlying agency problems and compromises auditor independence for f‌irms with a separation of cash f‌low rights and

voting rights. The f‌indings suggest that regulators in Canada and in other developed countries, when revising their future

regulations on audit committees, may need to emphasize the role of restricted-class shareholders in bolstering the audit

committee function and the auditing process.

Keywords: Shareholder rights, agency theory, shareholder value

INTRODUCTION

This paper examines the association between nonaudit

service purchases from external auditors and the corpo-

rate ownership structure. Specif‌ically, this study has a

twofold purpose. One purpose is to investigate whether

f‌irms with dual-class ownership structure purchase a sig-

nif‌icantly larger amount of auditor-provided services (APSs)

than f‌irms with single-class structure. A related purpose is

to examine the extent to which the market valuation of

accounting information is inf‌luenced by the perception of

auditing compromise resulting from such purchases. This

examination is motivated by the general criticism that non-

audit services provided by the external auditors could

impair the independence of the auditing process, and there-

fore the credibility of the f‌inancial statements (Levitt, 2000).

Yet, empirical research failed to provide consistent evidence

on whether the level of nonaudit service is associated with

the measure of biased f‌inancial statement presentation

(Frankel, Johnson and Nelson, 2002; Ashbaugh, Lafond and

Mayhew, 2003; Larcker and Richardson, 2004).1

Earlier analyticalresearch in audit pricing (e.g., DeAngelo,

1981; Beck, Frecka and Solomon, 1988a) demonstrates that

the economic bond between an auditor f‌irm and its clients

increases the auditor’s reliance on the client f‌irm; providing

nonaudit services reinforces the bonding relationship.

Evidence on knowledge spillovers has been provided by

Simunic (1984) and Palmrose (1986b), who f‌ind that audit

fees are higher in the presence of nonaudit services. While

prior studies are unable to quantify the exact costs and ben-

ef‌its of trade-offs related to the spillovers, Davis, Ricchiute

and Trumpeter (1993) provide evidence that such higher

audit fees are associated with a corresponding increase in

auditor effort, thus casting doubt on the claim that per-

forming nonaudit services leads auditors to compromise

objectivity.

*Address for correspondence: School of Business and Economics, Wilfrid Laurier

University,Waterloo, Ontario, Canada,N2L 3C5. Tel: (519) 884-0710, ext. 3293; E-mail:

fniu@wlu.ca

90 CORPORATE GOVERNANCE

Volume 16 Number 2 March 2008 © 2008 TheAuthor

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00665.x