Centre for Economic Policy Research

partners viewed as a threat to their franchise.
29
Tax advice is another comple-
mentary service that audit firms have increasingly provided. Accounting and 
taxation have often been closely associated in many people’s minds, especially in
those countries, notably Germany and Japan, with a clear link between the 
financial reporting and tax reporting systems.
Some sense of the growth of these non-auditing/accounting services can be
obtained from Figures 3.1 and 3.2, although they only cover a brief period. From
1994 to 1996, the auditing fee revenue for the Big 6 rose slightly in absolute 
dollar terms but dropped by more than 10% as a share of total revenue. Fees from
tax advisory services were flat in percentage terms at about 20%, while the areas
of gain were consulting and other MAS services. Following the dramatic 
revelations at Enron and other major corporations, there was a sharp increase in
2001 and 2002 in auditing and accounting fees both in absolute and percentage
terms. The change in percentages was driven in part by the separation of the 
consulting businesses by the end of 2002 in all the companies except Deloitte
Touche and Tomatsu.
These multiple services generate economies of scale and scope but create two
potential sources of conflict of interest. The most commonly discussed conflict is
the potential to pressure auditors to bias their judgements and opinions to limit
any loss of fees in the ‘other’ services. The second more subtle conflict is that 
auditors often evaluate systems or structuring (tax and financial) advice that were
put in place by their non-audit counterparts within the firm. With all the 
non-audit services, a potential boundary for the trade-off between economic 
efficiency and potential bias is between when the audit firm provides its expertise
to solve issues raised by the client and when it ‘sells’ new ideas for structures, 
especially if these are at the edge of acceptable current practice. For example, one
of the more publicized problems at Enron was its array of off-balance special 
purpose entities.
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Arthur Andersen was discovered to be marketing some of these
structures to Enron and other clients. Similarly in the tax area, two senior execu-
tives of Sprint PCS recently resigned after it was discovered they had employed
certain ‘aggressive’ tax structures marketed by Ernst & Young.
Both conflicts lead to questions of independence and are assumed to reduce the
likelihood of a negative audit outcome. These conflicts and debates about 
independence existed in the 1920s and became prominent again in the 1970s
(Simunic, 1984). In 1976, the Metcalf Committee Staff Study argued that a 
conflict of interest exists when an audit firm supplies MAS and audit services,
which it then has to audit for reliability and accuracy. The study claimed that any
negative views on the systems arising from the audit could impose a cost on the
32 Conflicts of Interest in the Financial Services Industry

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Accounting: Conflicts of Interest in Auditing and Consulting 33