The effect of non-audit fees on interest payments classification shifting: does internal governance and firm financial well-being matter?
Abstract
Purpose
This study examines the effect of non-audit fees (NAF) provisions on interest payments classification shifting. In addition, we investigate to what extent the NAF economic bonding and interest payments classification shifting is contingent on internal governance and firm financial well-being.
Design/methodology/approach
This study employed probit regression using a sample of UK non-financial firms indexed in FT UK (500) over the period from 2009 to 2017.
Findings
We find evidence that the economic bonding of NAF between external auditors and their clients is more likely to encourage managers in UK firms to manipulate operating cash flows through interest payment classification shifting. In addition, and interestingly, our results evince that classification-shifting may be the less costly and soft choice of managers in firms with strong governance and charging higher NAF. Furthermore, we show that financially distressed firms associated with their auditors in purchasing non-audit services are more prone to attempting to manipulate and engage in interest payments classification-shifting. Our result did not provide a significant effect of external auditor tenure on the interest payments classification shifting.
Research limitations/implications
Our findings are subject to the following limitations: First, this study uses a composite index to measure the quality of internal corporate governance. It focuses only on the board of directors, but this index does not reflect other internal governance mechanisms. Second, this study is subject to limited study time due to the implementation of key IFRS standards (IFRS 9 Financial Instruments and IFRS 15 Revenue from Contract with Customers) from 2018–2019.
Practical implications
This study was motivated by the UK’s Financial Reporting Council regulators' pressure on the Big 4 audit firms to move more audit time into main auditing activities, reduce cross-selling to audit clients and separate their audit practices by 2024. Overall, we provide new evidence that directs a close spotlight on the threats of NAF that are potentially useful to regulators, shareholders and investors.
Originality/value
It is motivated by the UK’s Financial Reporting Council regulators' pressure on the Big 4 to move more audit firm time into main auditing activities, reduce cross-selling to audit clients and separate their audit practices by 2024. Overall, we provide new evidence that directs a close spotlight on the threats of NAS that are potentially useful to regulators, shareholders and investors.
Keywords
Acknowledgements
The authors would like to thank Associate Prof Orthodoxia Kyriacou (current Editor of the JAAR), Prof Othmar Lehner (former Editor of the JAAR), the associate editor of the JAAR and the anonymous referees for their valuable comments and suggestions, which contributed to enhancing the quality of this paper. In addition, we are especially grateful for comments received from George Alexandrou and anonymous participants at the BAFA – South-East Area Group annual conference at Brunel University, London (June 2022).
Funding: The authors received no financial support for this research, authorship and/or publication of this article.
Citation
Hessian, M., Zalata, A.M. and Hussainey, K. (2024), "The effect of non-audit fees on interest payments classification shifting: does internal governance and firm financial well-being matter?", Journal of Applied Accounting Research, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JAAR-05-2023-0135
Publisher
:Emerald Publishing Limited
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