Non - audit services and financial reporting quality :

We provide evidence on the long standing concern on auditor conflicts of interest from providing non-audit services (NAS) to audit clients by using rarely explored NAS fee data from 1978-80. Using this earlier setting, we find cross-sectional evidence of improved earnings quality when auditors provide NAS, especially those related to information services. This is consistent with better audit quality from knowledge spillovers due to the joint offering of audit and consulting services. Events related to the repeal of these NAS disclosures in 1982 are associated with a small positive stock price reaction suggesting no adverse economic consequences of withdrawing NAS disclosures. Further, following the repeal of disclosure requirements we find no change in the earnings quality of client firms. In sum, data drawn from an earlier time period suggest that auditors’ reputational incentives, possible synergies and knowledge transfers imply that NAS offered by audit firms can be associated with improved audit and reporting quality in client firms. We thank our respective schools for financial support. We thank Ray Ball, Phil Berger, Mark DeFond, Aiyesha Dey, Bill Kinney, Doug Skinner, Hun-Tong Tan and workshop participants at Nanyang Technological University, the International Symposium on Audit Research conference at the University of Southern California, 2008 American Accounting Association annual meeting, and 2009 European Accounting Association Annual Congress for helpful comments. We are grateful to the staff at the University of Chicago Regenstein Library, Northwestern University Library and the Chicago Public Library (Main Branch) for assisting in the use of their microfiche collection of proxy statements. We thank Mark Maffet for his excellent research assistance. All errors are ours.