Centre for Economic Policy Research

Figure 3.1 Percentage of fee revenues by business unit
Notes: The years 1994-6 include revenue fee split percentages for the Big 6; 2000 and 2001 include revenue
fee split percentages for the Big 5; 2002 does not include Arthur Andersen and therefore includes the rev-
enue-fee split for the Big 4 only. Ernst & Young sold its consulting arm (MAS) prior to 2001. KPMG spun off
its consulting business in 2001 and had no MAS revenues in that year. In 2001 Arthur Andersen’s MAS rev-
enues excluded the revenues of Andersen Consulting that was spun off in that year.
1
Arthur Andersen 2001 numbers are Bowman’s estimates.
Source: ‘The 2003 Top 100 Firms’, Accounting Today, 17 March-6 April 2003, www.webcpa.com, pp 30-40.
Figure 3.2 Distribution of fee split revenues
Notes: The years 1994-6 include revenue fee split percentages for the Big 6; 2000 and 2001 include revenue
fee split percentages for the Big 5; 2002 does not include Arthur Andersen and therefore includes the rev-
enue-fee split for the Big 4 only. Ernst & Young sold its consulting arm (MAS) prior to 2001. KPMG spun off
its consulting business in 2001 and had no MAS revenues in that year. In 2001 Arthur Andersen’s MAS rev-
enues excluded the revenues of Andersen Consulting that was spun off in that year.
1
Arthur Andersen 2001 numbers are Bowman’s estimates.
Source: ‘The 2003 Top 100 Firms’, Accounting Today, 17 March-6 April 2003, www.webcpa.com, pp 30-40.
Auditing and Accounting Management Advisory Services Tax
Big 6 Big 5 Big 4
1994 1995 1996 2001
1
2002
100
90
80
70
60
50
40
30
20
10
0
Auditing and Accounting Management Advisory Services Tax
Big 6 Big 5 Big 4
1994 1995 1996 2001
1
2002
30
25
20
10
5
0

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whole audit firm as it would have a direct cost related to reimbursement for the
poor non-audit service supplied and lead to a loss of reputation.
Several studies have tried to assess how the combination of audit and non-audit
services affect efficiency and independence, providing some limited evidence on
economies of scope. Using fee data collected from a sample of publicly held US
companies, Simunic (1984) analysed a client’s decision to purchase MAS and audit
services when their production functions were interdependent. He tested for the
existence and pricing effects of such knowledge externalities or spillovers and
found significantly higher audit fees for clients who purchase MAS from their
auditors relative to clients who do not. Simunic claimed that this result is 
consistent with the existence of efficiencies from joint production as the quality
of audit services was improved. Extending Simunic’s analysis, Palmrose (1986)
uncovered similar effects when non-audit services were supplied by non-incum-
bent audit firms. Antle et al. (2002) produced results consistent with Simunic
(1984) and Palmrose (1986) where higher audit fees led to higher non-audit fees
and vice versa, consistent with economies of scope running in both directions. 
Parkash and Venables (1993) examine differences in the frequency of purchase
of recurring versus non-recurring MAS by audit clients. They suggest that audit
clients have incentives to limit non-audit purchases from incumbent auditors.
Their conjecture is that a perceived reduction in auditor independence reduces
audit credibility incurring added agency costs for companies as the value of the
auditors’ monitoring role is reduced. Their empirical tests indicate that agency
costs explained cross-sectional differences in the recurring purchase of non-audit
services but the strongest factor was informational and cost efficiency arising from
the industry specialization of the auditor. These results suggest that the econom-
ic efficiency can dominate agency costs. 
More recently studies have examined whether auditors’ fees for MAS are 
associated with abnormal accruals, used as a proxy for earnings management and
hence biased reporting. Frankel et al. (2002) find results consistent with non-audit
fees being positively associated with small earnings surprises and the magnitude
of discretionary accruals. As Kinney and Libbey (2002) point out, however, the
data and controls for omitted correlated variables makes the findings tenuous.
Antle et al. (2002) used a UK data sample, where audit and non-audit fees have
been disclosed for many years under the Companies Act, and an improved model
specification to examine the issue. Their results were consistent with economies
of scope when audit and non-audit services were combined. There was no 
significant effect of abnormal accruals on audit fees or non-audit fees, indicating
that these fees were not used as inducements to obtain favourable treatment. They
did find, however, that higher fees for non-audit services decreased abnormal
accruals. They interpreted this finding as being consistent with a productive effect
of non-audit services in lowering customers’ receivables and inventories, for
example. In addition, they provided evidence that audit fees had a positive effect
on abnormal accruals, suggesting that the higher fees lead to more frequent
acceptance of abnormal accruals.
31
DeFond et al. (2002) also find no evidence that
non-audit service fees impair auditor independence and that auditors are more
likely to issue going concern qualifications to clients that pay higher audit fees,
consistent with a risk-based propensity to audit more. Using proprietary data from
specific accounting firms, Bell et al. (2001) examined the relationship between
audit fees and risk of the audit client and concluded that risky clients bear higher
fees because of extra effort with more hours spent.
32
Collectively these studies suggest auditors expend effort to address aggressive or
risky accounting decisions made by clients, implying that the source of bias is in
the accounting rather than in the audit effort. The conflicts of interest arising
34 Conflicts of Interest in the Financial Services Industry

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from auditors providing non-audit and audit services have been a concern for
decades, yet the empirical evidence does not reveal a systematic pattern of these
conflicts creating obvious biases. Nevertheless, regulators’ concerns about 
compromises to auditors’ independence grew dramatically in the late 1990s, in
parallel with the dramatic growth in the share of the MAS practices relative to the
audit firm’s total revenue and profit.