Client Importance, Non-Audit Fees, and Abnormal Accruals

We use data on audit and non-audit fees paid to auditors, disclosed in proxy statements under SEC auditor independence rules, to assess whether client importance to auditor is associated with abnormal accruals. Our sample consists of 1,864 clients of Big-5 audit firms that revealed audit and non-audit fees in proxy statements filed between February 5, 2001 and June 30, 2001, and had data in Compustat to estimate abnormal accruals using the modified-Jones model. We measure client importance by the ratio of client fees to the audit firm's total US revenues. In view of anecdotal evidence suggesting that non-audit services are more profitable to the auditor than are audit services, we use the ratio of non-audit fees from a client to the audit firm's US revenues as a second measure of client importance. We do not find a statistically significant evidence of an association between abnormal accruals and either of the client importance measures. We also do not find evidence of a statistically significant association between abnormal accruals and client importance in subsets of the sample partitioned by the extent of client incentives to manipulate earnings (proxied by high leverage and high market to book ratio), auditor expertise (proxied by whether the auditor is the industry specialist), and insider influence on the board of directors (proxied by whether the CEO is the chairman, and by the percentage of employee directors). Thus we are unable to find evidence of any association between client importance and abnormal accruals. However, it is possible that client importance is significantly related to abnormal accruals in other cases which we have not considered, and our results should be interpreted subject to this caveat.