Can Fee Disclosure Be Trusted?

HEADNOTE

Does Sarbanes-Oxley's disclosures produce useful information?

IN AN EFFORT TO IMPROVE THE TRANSPARENCY of the client-auditor relationship, the securities and Exchange Commission since 2001 has required firms

to disclose the fees they pay to their external auditors for audit and non-audit services. The regulations presume that non-audit services are highly profitable relative to audit services and that a sufficiently high ratio of non-audit to audit fees creates an economic bond between the auditor and the client company that may impair the auditor's judgment and weaken its resolve in disputes with the client. In other words, the auditor may agree too readily with a client's questionable reporting choices in order to preserve non-audit fees. Reporting quality would be damaged.

ARE CLASSIFICATIONS CONSISTENT?

If fee disclosures are to be effective, they must be prepared in a consistent and unbiased manner or else the disclosed information is of little value. To determine the consistency of fee disclosures, we surveyed 31 external auditors (partners and managers) who regularly participate in the fee disclosure preparedness process. Participants were provided with a list of 25 different services typically provided to firms by their external auditors. The surveyed auditors were also provided with a copy of the classification rules that are to be used to classify services as (a) Audit, (b) Audit-Related, (c) Tax, or (d) Other. As summarized in Table !,only three of the services were classified into the same category by all participants. Fourteen of the services were classified consistently less than 75 percent of the time. In other words, services were not classified in a consistent manner among the participants even in a controlled environment in which there were no external pressures to bias the classification.