Carcello Et - Al (2020)

Auditor Independence and Fair Value Accounting:
An Examination of Nonaudit Fees and Goodwill Impairments*
JOSEPH V. CARCELLO, University of Tennessee
TERRY L. NEAL, University of Tennessee†
LAUREN C. REID, Wake Forest University
JONATHAN E. SHIPMAN, University of Arkansas
ABSTRACT
Inadequate testing of fair value accounting estimates, including goodwill, is often cited as an audit
deficiency in PCAOB inspection reports, and, in some cases, these deficiencies have led to enforcement
actions against the auditor. As a result of these issues, the PCAOB recently proposed a new auditing
standard for fair value accounting. While these regulatory actions suggest that auditors are challenged
by the fair value regime of accounting for goodwill, they also highlight an area where the auditor could
be influenced by their financial ties to a client. In this study, we test whether nonaudit fees are associ-
ated with goodwill impairment decision outcomes. Our results indicate that the nonaudit fees a client
pays are inversely related to the likelihood of impairment in settings where goodwill is likely to be
impaired. Additional examinations suggest that the negative relation between nonaudit fees and auditor
independence is driven by clients who are most incentivized to exert their influence over the auditor.
Indépendance de l’auditeur et comptabilité à la juste valeur :

une étude des honoraires pour services non liés à l’audit et de la
dépréciation du goodwill
RÉSUMÉ
Les tests inadéquats des estimations comptables de la juste valeur, notamment celle du goodwill,
sont souvent évoqués comme déficience de l’audit dans les rapports d’inspection du PCAOB,
déficience qui, dans certains cas, a mené à l’application de sanctions aux auditeurs. C’est pourquoi
le PCAOB a récemment proposé une nouvelle norme d’audit pour la comptabilisation à la juste
valeur. Bien que ces mesures réglementaires donnent à penser que les auditeurs sont aux prises
avec les difficultés que soulève le régime de comptabilisation du goodwill à la juste valeur, elles
mettent aussi en lumière un aspect du travail dans lequel l’auditeur pourrait être influencé par ses
liens financiers avec le client. Les auteurs vérifient dans leur étude si les honoraires pour services
non liés à l’audit sont associés aux conséquences des décisions relatives à la dépréciation du good-
will. Les résultats de leur analyse indiquent que les honoraires pour services non liés à l’audit que
* Accepted by Jeffrey Pittman. We thank two anonymous reviewers, Douglas Ayres, Don Bruce, Cory Cassell, Lauren
Cunningham, Dan Murphy, James Myers, Linda Myers, Joe Schroeder, Marcy Shepardson, Quinn Swanquist, Robert
Whited, and workshop participants at Indiana University, the University of Arkansas, and the University of Tennessee
for helpful comments and suggestions on earlier versions of the paper. This paper is based on Jonathan Shipman’s disser-
tation titled “Do Non-Audit Fees Impair Auditor Independence? Using Goodwill Accounting to Help Reconcile the
Debate,” performed while at the University of Tennessee. Data availability: All data used are publicly available from
sources cited in the text.
† Corresponding author.
Contemporary Accounting Research Vol. 37 No. 1 (Spring 2020) pp. 189–217 © CAAA
doi:10.1111/1911-3846.12514
190 Contemporary Accounting Research
verse un client sont en relation inverse avec la probabilité de dépréciation dans les situations où la
dépréciation du goodwill est probable. Des analyses supplémentaires semblent indiquer que la rela-
tion négative entre les honoraires pour services non liés à l’audit et l’indépendance de l’auditeur
est tributaire des clients qui sont le plus motivés à exercer leur influence sur l’auditeur.
1. Introduction
Prior to SFAS 142 (now ASC section 350-20), goodwill accounting was fairly straightforward and
required little involvement from the auditor. The issuance of SFAS 142 in 2001, however, dramati-
cally changed the process of accounting for goodwill. SFAS 142 ended goodwill amortization and
required annual impairment testing. The introduction of ongoing impairment monitoring significantly
changed the role of the auditor related to goodwill accounting. The auditor must now devote signifi-
cant time to the testing of this account, ensuring that management has properly assessed and, if neces-
sary, written down goodwill. Given that prior literature has shown that management has the incentive
to manipulate this account (e.g., Beatty and Weber 2006; Muller et al. 2012; Ramanna and Watts
2012), it is critical for the external auditor to remain independent as higher levels of independence
should result in enhanced auditor judgment and a related lower risk of goodwill being manipulated by
management. However, PCAOB inspection reports reveal that testing around goodwill impairments is
commonly cited as an audit deficiency (Hanson 2012; PCAOB 2017a). In recent years, the PCAOB
has also issued numerous enforcement actions citing violations in auditing accounting estimates,
including goodwill (PCAOB 2010, 2011, 2013, 2015).
Due to these inspection findings and enforcement actions, the PCAOB proposed a new auditing
standard, Auditing Accounting Estimates, Including Fair Value Measurements, on June 1, 2017
(PCAOB 2017b). This recently proposed standard introduces a risk-based approach designed to
strengthen the audits of all accounting estimates. It would require auditors to identify and evaluate
potential management bias and increase professional skepticism through various techniques,
including audit team brainstorming. While these regulatory actions suggest that auditors are chal-
lenged by the new fair value regime of accounting for goodwill, they also highlight a situation in
which the auditor could be influenced by their financial ties to a client. Ayres et al. (2019) docu-
ment that goodwill impairments are associated with a significant increase in the likelihood of
auditor dismissals, suggesting there is an opportunity for potential independence issues given the
auditor’s desire to avoid being dismissed by a client.1 The combination of subjective judgments,
potential management manipulation, and competing auditor-client incentives suggests an analysis Why this
of goodwill impairments can provide important insights into the role of auditor independence around paper?
fair value accounting.
The potential for diminished independence in the auditor-client relationship has long been a
concern of regulators, particularly in the presence of significant nonaudit service fees. While the
Sarbanes-Oxley Act (SOX) proscribed auditors from providing many nonaudit services to audit
clients, an extensive list of permissible nonaudit services remains (SEC 2002).2,3 These permissi-
ble services still make up a sizable portion of the fees that auditors collect from their audit clients
(approximately 14–15 percent of the total fees for the observations examined in this paper),
suggesting that the potential for diminished independence may remain. Studies examining inves-
tor perceptions of nonaudit fees provide support for these independence concerns (Higgs and
1. In a 2009 survey, numerous senior financial executives cited “auditor issues” as the most significant problem they
faced during the goodwill impairment process, which further highlights relationship issues between auditors and cli-
ents in these situations (Holtzman and Sinnett 2009, 27).
2. Throughout the paper, any discussion of nonaudit services and/or the related fees for those services refers to addi-
tional nonaudit services purchased from the company’s current external auditor. The fees are as classified by Audit
Analytics and follow both classification guidelines from the SEC and prior literature in this area.
3. This list includes services such as benefit plan audits, assistance related to mergers and acquisitions, attestation services,
accounting consultations, tax compliance, tax planning, tax advice, and operational audits.
CAR Vol. 37 No. 1 (Spring 2020)

Auditor Independence and Fair Value Accounting 191
Skantz 2006; Khurana and Raman 2006; Krishnan et al. 2005). Although earlier studies examin-
ing outcomes of auditor actions generally find no evidence of a detrimental impact of nonaudit
services on auditor independence and audit quality (e.g., Agrawal and Chadha 2005; Ashbaugh
et al. 2003; Callaghan et al. 2009; Chung and Kallapur 2003; DeFond et al. 2002; Geiger and
Rama 2003; Larcker and Richardson 2004; Li 2009; Raghunandan et al. 2003; Reynolds et al.
2004; Stanley and DeZoort 2007), more recent studies document some negative audit conse-
quences of providing nonaudit services (e.g., Blay and Geiger 2013; Gaver and Paterson 2014;
Kanagaretnam et al. 2010; Paterson and Valencia 2011; Rice and Weber 2012). The purpose
of this paper is to examine whether currently permissible nonaudit services (which are often Purpose
considered to detrimentally affect auditor independence) impact the accounting for goodwill
impairments.4
In order to properly test for an association between nonaudit fees and auditor indepen-
dence in the assessment of goodwill, one must identify a sample of observations where a good-
will impairment most likely should have been recorded. Consistent with prior literature
(e.g., Beatty and Weber 2006; Ramanna and Watts 2012), we use market-to-book ratios less
Sample
than one to help identify when accounts on a company’s books are overvalued and the com- Selection
pany has a high probability of experiencing a goodwill impairment. Practitioners, industry par-
ticipants, and regulators have also argued that equity market-based impairment indicators are
reliable external signals of realized impairment (Fox 2008; Harrington et al. 2012; Tergesen
2002). We use a primary sample of 2,126 companies with a market-to-book ratio less than one
for two consecutive years and a material level of goodwill.5 Having a material level of good-
will ensures that there is the potential for a material goodwill impairment. We then examine
whether the auditor’s propensity to require a goodwill impairment is associated with the level
of nonaudit services provided to that audit client. The findings of these analyses suggest that
the level of nonaudit fees of a client is associated with a reduction in the likelihood that a com-
pany records a goodwill impairment in settings in which goodwill is likely to be impaired.
Because establishing an appropriate counterfactual sample is critical to the validity of our
inferences, we next perform several additional tests to help dispel concerns that our findings are
the product of our primary sample construction decisions. First, we compare the impairment rate
for companies with a market-to-book below one to those with a market-to-book above one and
find that the rate is significantly higher (as expected) for companies with a market-to-book below
one for two years in a row. Second, we place two additional restrictions on our sample to identify
company-year observations most likely in need of an impairment: (i) companies that impair good-
will during our sample period and (ii) companies that impair goodwill in the current year or sub-
sequent three years. In both of the more restricted samples, we continue to find that higher
nonaudit fees are associated with reduced impairment recognition. Third, we construct two alter-
native samples—one which identifies counterfactuals from a regulator’s perspective (using SEC
Comment Letters) and one which identifies counterfactuals from a financial statement perspective
(using a prediction model). In both of these alternative samples, we continue to find strong evidence
4. While there is some preliminary evidence of independence issues surrounding nonaudit fees and discretionary
accounting estimates, these studies do not examine fair value accounting and are limited to companies in specific
(and arguably unique) industries, such as insurance and banking (Gaver and Paterson 2014; Kanagaretnam et al.
2010). By examining goodwill write-offs, we are able to comment on independence issues in a fair market-value
context. Furthermore, given the wide range of companies that may experience a goodwill impairment and the regu-
latory attention paid to goodwill and other fair value estimates, it is important to empirically examine this area.
5. Materiality is defined as 0.5 percent or more of revenues. We employ this materiality threshold to focus on only those
impairment transactions most likely to be of consequence to a company. This cutoff is in line with survey responses
from eight of the nine largest U.S. audit firms: BDO USA, LLP; Crowe Horwath LLP; Deloitte & Touche LLP; Ernst &
Young LLP; Grant Thornton LLP; KPMG LLP; McGladrey LLP; and PricewaterhouseCoopers LLP (Eilifsen and
Messier 2015). We test the sensitivity of this threshold in the additional analyses and robustness section of the paper.

that nonaudit fees are negatively associated with the likelihood of recording a material goodwill
impairment.
We also perform additional analyses that provide further support for the finding of a negative
relation between nonaudit fees and goodwill impairments. First, we perform a series of cross-
sectional analyses that examine the effects of client incentives on the relation between nonaudit
fees and auditor independence. If the documented association between nonaudit fees and goodwill
impairment is due to client preferences for generally avoiding the recognition of a goodwill
impairment, then we would expect the association to vary based on the presence of client incen-
tives. Using executive turnover, restructuring costs, going-concern opinions, and market value as
proxies for the strength of client incentives, our results suggest that lower incentives for avoiding
goodwill impairment weaken the negative relation between nonaudit fees and auditor indepen-
dence. Specifically, we find that nonaudit fees are generally only associated with impairment deci-
sion outcomes when clients are more incentivized to avoid an impairment.6 Second, we examine
the relation between nonaudit fees and the amount of a goodwill impairment taken relative to the
company’s total goodwill balance. This analysis offers insights into whether clients with a higher
level of nonaudit fees record a lower impairment amount. The results of this test suggest that cli-
ents who pay higher amounts of nonaudit fees impair lower amounts relative to other clients.
Third, we decompose nonaudit fees into specific categories and find that the observed negative
association between nonaudit fees and goodwill impairments is driven by audit-related fees.
Fourth, we perform tests to gain comfort that our documented results are not caused by some
companies simply having an inability to pay for nonaudit services. Overall, our results provide
consistent evidence that nonaudit services have a significant and negative association with good-
will impairment decisions.
Our results contribute to both the academic and regulatory communities. We provide the first
evidence of auditor independence issues surrounding the auditing of goodwill. Given the noted dif-
Main
ficulties and particular regulatory attention paid to auditing goodwill, it is meaningful to understand results
the potential independence concerns surrounding this important account. We also provide support
for the regulatory concerns and actions surrounding the auditing of fair value estimates in general.
Specifically, our findings highlight that a lack of auditor independence may have greater conse-
quences in fair value accounting settings due to the substantial judgment involved. This concern is
further highlighted by the variation we observe in our cross-sectional examination of client incen-
tives, as it suggests that clients situationally exert their influence. The findings of this paper also
offer some validation for the change in independence standards that regulators imposed in the early
2000s. Importantly, however, our results suggest that even though the passage of SOX limited the
nonaudit services that clients can purchase from their auditor, post-SOX levels of nonaudit fees
may still undermine auditor independence.
The remainder of the paper is organized as follows. The next section provides background
information. The research design and sample selection processes are outlined in section 3. Results
are discussed in section 4, and section 5 presents several additional analyses and robustness
checks. Concluding remarks are presented in section 6.
2. Background
Accounting for goodwill
Over the past few decades, there has been an increasing trend in the use of fair value estimates in
financial reporting practices. This trend is evidenced by the issuance and/or revision of numerous
6. The presence of each of these characteristics increases the likelihood that the company is either going through a
transition that makes them more likely to be comfortable with, or perhaps prefer, recording an impairment (execu-
tive turnover; company restructuring), is in a financial position that prevents them from being able to credibly
defend avoiding the recording of an impairment (going concern), or has a market presence that reduces the negative
consequences of recording an impairment (small market value). Please refer to section 5 for more details.

financial statement standards involving accounting estimates.7 The passage of SFAS 142 (now
ASC section 350-20) in 2001 radically reformed the accounting treatment for goodwill by elimi-
nating goodwill amortization and establishing annual impairment tests by reporting unit. In order
to test goodwill for impairment, management must determine how to allocate goodwill across
reporting units and estimate the discounted future cash flows for each reporting unit to assess a
unit’s net asset value (Ramanna and Watts 2012). This process introduces significant management
discretion because the inputs are based solely on management estimates, which are difficult and,
in some cases, essentially impossible to verify (Ayres et al. 2019).
Due to the judgment required, goodwill impairments are “likely to be manipulated” and used
to “manage financial reports opportunistically” (Watts 2003, 217; Ramanna and Watts 2012,
777). Prior literature has documented instances of this manipulation occurring by highlighting
how management uses impairments to manage earnings. Beatty and Weber (2006) find that com-
panies are less apt to write down goodwill when the impairment may cause a debt covenant viola-
tion or a potential issue with exchange listing requirements. They also find that companies with
earnings-based bonus plans and companies with CEOs who have been in the position for a rela-
tively long period of time are less likely to record a goodwill impairment. In addition, Ramanna
and Watts (2012) find some evidence that managers are influenced by concerns related to debt
covenant violations, executive compensation, and CEO reputation, which can lead them to avoid
goodwill write-offs despite market indicators that suggest that their company’s goodwill is
impaired. Exploring the underlying motivations managers have to delay goodwill write-offs,
Muller et al. (2012) find that managers use the time for their personal gain by selling shares in
the two years prior to the announcement of a goodwill write-off. These management actions high-
light the importance of auditor independence when testing goodwill for potential impairment.
Higher levels of independence should result in enhanced auditor judgment and a related lower
risk of goodwill being manipulated by management.
From an audit perspective, AS 2502 (formerly AU 328), Auditing Fair Value Measurements
and Disclosures, requires the auditor to evaluate management’s assumptions and assess manage-
ment’s fair value measurements to determine whether the entity’s process conforms to GAAP
(PCAOB 2002). Therefore, the auditor is charged with evaluating management’s goodwill assess-
ment each year and externally monitoring the goodwill account, which is highly subjective. In
fact, now that risks of material misstatement are included in the United Kingdom’s audit reports,
we know that the impairment of goodwill is the most commonly cited risk and is mentioned in
43 percent of audit reports reviewed by the Financial Reporting Council (FRC), which the FRC
believes is “perhaps unsurprising” because it is one of the “critical areas of management judgment
and of particular significance to the valuation of companies” (FRC 2016, 15).8 However, the
often-conflicting goals of managers and auditors suggest that the goodwill impairment process
can lead to tension in the auditor-client relationship. A 2009 survey of 2,500 senior financial
executives alluded to this tension when they were asked to identify the most significant chal-
lenges they encountered during the goodwill impairment process (Holtzman and Sinnett 2009).
A commonly cited challenge the financial executives faced during their most recent impairment
was “auditor issues”(Holtzman and Sinnett 2009, 27). A result of this tension is highlighted by
Ayres et al. (2019), who document an increase in auditor dismissals after a goodwill impairment
has occurred. The presence of such a significant consequence to the auditor suggests that auditor
7. For example, over the past few decades, SFAS 115, SFAS 121, SFAS 123R, SFAS 133, SFAS 141R, and SFAS
142 were issued, which require the determination of fair value in the accounting for investment securities, impairments
of long-lived assets, stock-based compensation, derivatives, business combinations, and goodwill, respectively.
8. Since the reporting of risks in the audit report is not yet required in the United States, we do not have this information for
companies listed in the United States. However, it is interesting to note that the PCAOB’s proposed auditing standard for a
new reporting model uses “the auditor’s evaluation of the company’s goodwill impairment assessment” as its first example
of a critical audit matter that could be included in the auditor’s report (PCAOB 2016, 20).

incentives may lead to potential independence concerns in the goodwill impairment process.
These possible independence issues may be one reason that regulators have noted the difficulty
auditors face in reliably auditing this area. PCAOB inspection reports, for example, commonly
cite goodwill impairment testing as an audit deficiency (Hanson 2012; PCAOB 2017a).
In recent years, the PCAOB has also issued numerous enforcement actions citing violations
in auditing accounting estimates, including goodwill. For example, one company’s financial state-
ments disclosed that goodwill represented nearly 75 percent of total assets, but there was no evi-
dence that the auditors had obtained and reviewed the company’s goodwill valuation. Instead, the
auditors simply relied on management’s representation that an impairment should not be recorded
(PCAOB 2011). As a result of these audit failures and others noted in the enforcement action, the
PCAOB revoked the audit firm’s registration and permanently barred the individual auditors
(PCAOB 2011). A similar pattern of events was noted in many other PCAOB enforcement
actions regarding the failure to perform sufficient procedures to test the assumptions and estimates
used in management’s goodwill impairment analysis (e.g., PCAOB 2010, 2013, 2015).
Due to these inspection findings and enforcement actions, the PCAOB proposed a new auditing
standard, Auditing Accounting Estimates, Including Fair Value Measurements, on June 1, 2017
(PCAOB 2017b). This recently proposed standard introduces a risk-based approach designed to
strengthen the audits of all accounting estimates. It would require auditors to identify and evaluate
potential management bias and increase professional skepticism through various techniques,
including audit team brainstorming. Both the regulator findings and the research documenting
negative auditor-client relationship consequences suggest that the area of goodwill impairments
may be subject to increased auditor independence concerns.
Nonaudit services and auditor independence

In their revision of auditor independence requirements, the SEC extensively discussed concerns
about the impact that nonaudit relationships between auditors and their audit clients have on both
an auditor’s objectivity and investor confidence in financial statements (SEC 2001). They
expressed specific concerns that the economic incentives from nonaudit services, both in terms of
the magnitude of the services performed and their relative profitability compared with audit services,
could encourage an auditor to behave with the primary intention of preserving their relationship with
an audit client, thus increasing the risk that the auditor would behave less objectively. While auditors
are now prohibited from providing many nonaudit services to audit clients, an extensive list of permis-
sible nonaudit services remains (e.g., benefit plan audits, assistance related to mergers and acquisi-
tions, attestation services, accounting consultations, tax services, and operational audits). Although
audit firms decreased their nonaudit workload following the passage of SOX, these permissible ser-
vices still represent a sizable portion of the fees that auditors collect from their audit clients (approxi-
mately 14–15 percent of the total fees for the observations examined in this paper), suggesting that
the potential for diminished independence may persist.9
The above concerns, among others, led the SEC to direct companies to disclose the amount
and types of fees paid to their auditor—a disclosure process that went into effect on February
5, 2001 (SEC 2001). Since these disclosures began, academics have examined the relation
between nonaudit fees and auditor independence. Studies in this area have included investor
responses as well as direct attempts at finding instances of impaired independence. Prior literature
investigating investor responses has documented several instances of concern about nonaudit fees.
In analyzing investor perceptions, Krishnan et al. (2005) investigate the association between fee-
based measures of nonaudit service purchases and earnings response coefficients (ERCs). They
find that the nonaudit fee ratio and the level of nonaudit fees were negatively associated with
ERCs. Higgs and Skantz (2006) also use ERCs to assess investor perceptions of fees. For audit
9. Furthermore, the serial correlation in NAS fees for our sample is 0.948, suggesting the nonaudit services provided
to an audit client also have certain annuity-like characteristics associated with them.

fees, the authors find evidence consistent with the market interpreting abnormally high audit fees
as a signal of high earnings quality. When analyzing nonaudit fees, however, the authors find evi-
dence that abnormally high nonaudit fees impair perceived auditor independence. Further testing
investor perceptions of nonaudit fees, Khurana and Raman (2006) employ the client-specific ex
ante cost of equity capital as a proxy for investor perceptions of financial reporting credibility.
They find that the higher the nonaudit fees paid to the auditor, the greater the implied threat to
auditor independence and the lower the financial reporting credibility of a Big 5 audit.10 Taken
together, these results provide evidence that investors perceive nonaudit fees as a detriment to
auditor independence.
While the concerns expressed by investors suggest nonaudit fees are problematic, the
majority of prior literature fails to find evidence of actual auditor independence being
impaired (e.g., Agrawal and Chadha 2005; Ashbaugh et al. 2003; Callaghan et al. 2009;
Chung and Kallapur 2003; DeFond et al. 2002; Geiger and Rama 2003; Kinney et al. 2004;
Larcker and Richardson 2004; Li 2009; Raghunandan et al. 2003; Reynolds et al. 2004;
Stanley and DeZoort 2007). 11 More recent findings, however, suggest that some apprehen-
sion may be warranted. Studying behavior in the post-SOX era, Blay and Geiger (2013)
find some evidence that a higher level of concurrent nonaudit fees is associated with a
lower propensity to issue a going-concern modification. Blay and Geiger (2013) note, how-
ever, that their “findings related to going concern decisions and NAS fees in the United
States are sensitive to both the time period examined and the selection of appropriate con-
trol samples of distressed non-GCM firms” (p. 602). Rice and Weber (2012) find an inverse
association between nonaudit services and the likelihood of issuing an adverse internal
control report in the post-SOX era. 12 Similarly, Paterson and Valencia (2011) examine
audit quality in the post-SOX period and find that audit-related fees (both recurring and
nonrecurring) are positively associated with restatements. Importantly, however, they find
that recurring tax nonaudit service fees lead to knowledge spillover and, in turn, higher
audit quality.
Nonaudit fees and goodwill impairments

The purpose of this paper is to examine whether currently permissible nonaudit services (which are
often considered to detrimentally affect auditor independence) impact the accounting for goodwill
impairments. Given the wide range of companies and industries that are impacted by goodwill write-
offs, our analysis allows us to provide important insights into auditor independence in broad fair value
settings. Prior literature suggests there is some potential for independence concerns around discretion-
ary accounting estimates. Examining the banking industry, Kanagaretnam et al. (2010) find that unex-
pected nonaudit fees are associated with lower discretionary loan loss provisions. Gaver and Paterson
(2014) study the property–casualty insurance industry and report that loss reserve bias is lower when
nonaudit services are provided from a third party (i.e., not the external auditor). While these studies
provide evidence of independence issues surrounding nonaudit fees in discretionary accounting esti-
mates for banking and insurance companies, it remains unknown whether the findings documented
would be similar in an examination of fair value accounting, including goodwill impairments. In addi-
tion, the industries examined in these studies are unique, whereas our findings should extend to any
company with material goodwill.
10. Other parties have also expressed concerns. Schmidt (2012) finds that when plaintiff attorneys argue that auditor
independence was impaired due to dependence on nonaudit fees, restatement-related audit litigation is more likely
to result in an auditor settlement and a larger amount of settlement. She concludes that audit litigants act as if they
believe nonaudit fees will strengthen the case against the auditor.
11. Findings from other countries have provided some support for the idea that nonaudit fees impair auditor indepen-
dence (Basioudis et al. 2008; Firth 2002; Sharma and Sidhu 2001).
12. De Simone et al. (2015) also find that companies purchasing tax nonaudit services are significantly less likely to
disclose a material weakness, suggesting that tax nonaudit fees improve financial reporting quality.

3. Research methodology and sample selection

Research methodology
To test the effect of nonaudit fees on the likelihood of goodwill impairment, we estimate the following
logistic regression model:
IMPit = β0 + β1 ðLN_NONAUDIT it or FEE_RATIOit Þ + βx CONTROLSit + IND_FE + YEAR_FE + εit , ð1Þ
where i denotes firm, t denotes year, and IMP is equal to one if the firm recorded a material goodwill
impairment (defined as greater than 0.5 percent of revenue) during the fiscal year, and zero otherwise.
LN_NONAUDIT = natural log of the sum of 1 + nonaudit fees (in millions) paid to current
fiscal year auditor.
FEE_RATIO = sum of nonaudit fees divided by total fees paid to current fiscal year auditor.
CONTROLS = vector of control variables.
IND_FE = industry fixed effects.
YEAR_FE = year fixed effects. Variables
ε = error term.
The dependent variable IMP is an indicator variable equal to one if the company recorded a
material goodwill impairment during the fiscal year, and zero otherwise. Consistent with prior research,
the variable of interest in this model is either the natural log of nonaudit fees (LN_NONAUDIT) or the
ratio of nonaudit fees to total fees paid to the company’s auditor (FEE_RATIO) (Blay and Geiger 2013;
DeFond et al. 2002; Geiger and Rama 2003; Li 2009).13 As described in section 2, we test whether the
level of nonaudit fees is associated with the likelihood of impairment. An insignificant coefficient on the
variables of interest would suggest a lack of association between nonaudit fees and the probability of a
goodwill impairment. A negative and significant coefficient would indicate that higher levels of nonaudit
fees are associated with a reduced likelihood of recording a goodwill impairment, while a positive and
significant coefficient would suggest that the additional exposure garnered through nonaudit services is
actually associated with an increase in the likelihood that an auditor requires a goodwill impairment.
Control variables derived from prior literature are included in this multiple regression analysis.
We include LN_AUDITFEES in the version of the model that employs LN_NONAUDIT and
LN_TOTALFEES in the version of the model using FEE_RATIO to control for the level of fees (audit
and total, respectively) paid by the client (Blay and Geiger 2013; DeFond et al. 2002; Geiger and
Rama 2003; Li 2009). LN_MKVALT is the natural log of the company’s market value of equity and
is included to control for client size. Following Beatty and Weber (2006), we include the percentage
that a company’s market value of assets is below book value of assets (IMP_PCT) to control for mar-
ket perceptions of a client’s valuation. In addition to these current period market valuation factors, we
also control for the market return over the current year (ANN_RETURN) and the SD of that return
(STDEV). GDWL_PCT is the pre-impairment percentage of a firm’s assets that are composed of good-
will (Ramanna and Watts 2012). LEVERAGE is the ratio of total short- and long-term debt to pre-
impairment company book value. We also control for the amount of any nonintangible assets written
down by the company (OTHER_IMP). To control for the fact that the goodwill impairments occur on
a segment-by-segment basis, and the related change in potential impairment that occurs with an
increasing number of segments, we also control for the natural log of the total number of operating
segments of the firm (LN_SEGMENTS) (Francis and Yu 2009).14 Several other firm performance
13. In untabulated analyses, we use a fee model to estimate abnormal nonaudit fees and abnormal audit fees. If we use
these variables instead of LN_NONAUDIT and LN_AUDITFEES, our results are qualitatively unchanged (p < 0.01).
14. Because goodwill is tested on a segment-by-segment basis, multiple segments within a firm could add noise to the model.
Although we control for the number of segments in the model, we eliminate the potential of any noise by reperforming our
tests using only those observations with one reporting segment. Even with a significantly reduced sample, our results are sim-
ilar. Specifically, the coefficient on LN_NONAUDIT (FEE_RATIO) is negative and significant at the p < 0.01 (p < 0.05)
level.

TABLE 1
Sample selection
Observations
Observations with all required COMPUSTAT data (fiscal years 2005 through 2015) 35,127
Less:
Observations without fee data in Audit Analytics (5,505)
Observations without necessary stock price information in CRSP (3,502)
Observations without a material level of goodwill in the current year (1,016)
Observations without a material level of goodwill in the prior year (1,228)
Observations without a market value that is materially less than book
value in the current year (19,909)
Observations without a market value that is materially less than book
value in the prior year (1,841)
Total observations meeting full sample criteria 2,126
Note: This table outlines the selection process for the primary sample.
characteristics are also included. LOSS is an indicator variable that is equal to one if the firm incurred
a pre-impairment loss for the fiscal year ended (Hayn and Hughes 2006), and zero otherwise. ROA is
the company’s pre-impairment net income divided by the average total assets for the year (Gu and
Lev 2011). EBITDA_CHANGE is the change in a company’s EBITDA from time t − 1 to time
t divided by the total firm market value of equity. GW_ACQ (LAG_GW_ACQ) is an indicator variable
included for observations in which the company completed an acquisition that increased goodwill dur-
ing the current (prior) fiscal year (AbuGhazaleh et al. 2011). We also control for revenue growth
(GROWTH) as high-growth firms are potentially more likely to engage in acquisitions and subse-
quently impair goodwill (Reynolds et al. 2004).15 Additionally, we consider the possibility that some
firms may engage in “big baths” and include the presence of restructuring costs (RESTRUCTURE)
and executive turnover (CEO_CHANGE and CFO_CHANGE) as control variables (Jarva 2014;
Ramanna and Watts 2012). Furthermore, we control for whether the firm engaged a Big 4 auditor
(BIGN) and whether the company’s auditor issued a going-concern opinion (GC).16 We also control
for industry (IND_FE) and year (YEAR_FE) specific characteristics. Industries are classified using
two-digit SIC code. All standard errors are robust and clustered at the company level (Petersen 2009).
All variables are defined in the Appendix.
Sample selection
Table 1 presents the sample construction. We first obtain financial data from COMPUSTAT for
all companies with fiscal years beginning on or after July 1, 2005, and ending by May 31, 2016
(COMPUSTAT fiscal years 2005 through 2015). Although SFAS 142 went into effect for fiscal
years beginning on or after December 15, 2001, the later beginning date allows for testing relations
after a “settling in” of the significant regulatory changes implemented during the early part of
15. Because low-growth companies may experience significantly less goodwill activity than high-growth companies,
we dichotomize GROWTH at the sample median and interact a high-growth variable with each of our variables of
interest. In untabulated analyses, we find that the coefficients on LN_NONAUDIT and FEE_RATIO, which represent
the effects of nonaudit fees for low-growth companies, are both negative and statistically significant. Furthermore,
both of the interaction terms are insignificant, suggesting that there is not a significant difference in the association
between nonaudit fees and goodwill impairments for high- and low-growth companies.
16. In untabulated analyses, we interact BIGN with our variables of interest. Although neither interaction term is statisti-
cally significant, the effect for non-Big N auditors is not statistically significant, while the effect for Big N auditors
remains highly significant. This provides some weak evidence that our results are primarily driven by companies
audited by Big N auditors.

the decade.17 The amount of audit fees and the amount of nonaudit fees are variables from Audit
Analytics, while stock returns data is collected from the CRSP. We only retain companies with
pre-impairment goodwill larger than 0.5 percent of revenue. This eliminates impairment decisions
Sample
that are unlikely to involve auditor scrutiny. Selection
The sample is limited to companies with a market value that is materially less than book value
(a market-to-book ratio materially less than one) for two consecutive years.18,19 This constraint limits
the sample to instances where the market has indicated some type of impairment is likely warranted
(Beatty and Weber 2006; Churyk 2005; Fox 2008; Harrington et al. 2012; Ramanna and Watts 2012;
Tergesen 2002) and helps to ensure that we identify reasonable counterfactuals, thus making them
proper for testing auditor independence. To be included in the sample, the observations must contain
all requisite financial data from COMPUSTAT, all fee-related data from Audit Analytics, and stock
return data from CRSP. Our final sample consists of 2,126 observations.
4. Results
Descriptive statistics
Table 2 presents some descriptive statistics for the market-based sample of 2,126 firm-year obser-
vations. Approximately 31 percent of the observations in the sample have a material impairment.
On average, companies in the sample pay nonaudit fees of $597,000 to their current auditor.20
These same companies also pay an average of $2.66 million in audit fees annually for an average
of approximately $3.26 million in total fees annually.21,22
Table 3 presents a comparison of means between the subsample of companies recording a
goodwill impairment and the subsample of companies not recording a goodwill impairment. The
first two columns present the observation counts and variable means for the nonimpairment sam-
ple. The third and fourth columns present the observation counts and variable means for the impair-
ment sample. From a descriptive standpoint, there is no statistical difference between the two
subsamples in terms of audit fees. However, the subsample of nonimpairers has a significantly higher
level of nonaudit and total fees, as well as a significantly higher fee ratio. Beyond the fee variables,
there are also other differences between those companies that impair and those that do not. Impairment
companies are smaller in size than nonimpairment companies, are more likely than nonimpairment
17. To test the sensitivity of results to this time period cutoff, we reperform analyses using all observations since the
implementation of SFAS 142. In order to do so, we have to drop CEO_CHANGE and CFO_CHANGE as control
variables because they were not widely available until COMPUSTAT fiscal year 2005. Untabulated results remain
qualitatively unchanged.
18. We require that market value is materially less than book value to ensure that a company has the ability to record a
material goodwill impairment without having to surpass a market-to-book ratio equal to one. To ensure that results
are not sensitive to this cutoff, we reperform analyses on a sample that also includes those observations with a
market-to-book immaterially less than one and find results that are qualitatively unchanged.
19. We require two years of a market-to-book ratio less than one to ensure that the company’s goodwill is economically
impaired because a depressed market value in one year is not necessarily a definitive signal of goodwill impairment
(Ramanna and Watts 2012). However, if we instead only require a market-to-book ratio less than one for one year,
our sample consists of 4,183 observations and our inferences are similar throughout. While this approach is less
stringent than our primary sample construction, it is consistent with the threshold suggested by practitioners, indus-
try participants, and regulators regarding what is a reliable external signal of realized impairment (Fox 2008; Har-
rington et al. 2012; Tergesen 2002). We also consider several alternative sample identification approaches in
section 4.
20. For nonaudit services, 252 observations have zero fees. To test the sensitivity of our results to these observations,
we reperform analyses excluding these observations and find that results remain qualitatively unchanged.
21. Some control variables (e.g., ANN_RETURN having a large negative mean value) may seem somewhat abnormal in
their magnitude; however, these values are reasonable based on the sample construction threshold that requires
observations to be likely impairers.
22. All descriptive statistics and results are presented unwinsorized throughout. To test the sensitivity of this decision,
we also reperform all analyses with all continuous variables winsorized at the 1st and 99th percentiles. Results are
consistent throughout.

TABLE 2
Descriptive statistics
Variable N Mean SD p(25) Median p(75)
IMP 2,126 0.310 0.463 0.000 0.000 1.000

NONAUDIT_FEES 2,126 0.597 2.933 0.020 0.070 0.228
AUDIT_FEES 2,126 2.661 9.485 0.247 0.645 1.667
FEE_RATIO 2,126 0.145 0.129 0.042 0.122 0.223
TOTAL_FEES 2,126 3.258 12.212 0.301 0.722 1.906
BIGN 2,126 0.527 0.499 0.000 1.000 1.000
MKVALT 2,126 2,362.144 13,000.000 38.241 107.025 488.207
IMP_PCT 2,126 0.123 0.131 0.028 0.064 0.184
GDWL_PCT 2,126 0.115 0.157 0.013 0.038 0.158
LOSS 2,126 0.425 0.494 0.000 0.000 1.000
LEVERAGE 2,126 1.024 1.503 0.199 0.564 1.242
ROA 2,126 −0.026 0.099 −0.026 0.003 0.010
GW_ACQ 2,126 0.371 0.483 0.000 0.000 1.000
EBITDA_CHANGE 2,126 −0.126 0.848 −0.112 −0.005 0.046
SEGMENTS 2,126 1.181 0.844 1.000 1.000 1.000
ANN_RETURN 2,126 −0.039 0.585 −0.339 −0.049 0.181
STDEV 2,126 0.138 0.098 0.072 0.114 0.178
OTHER_IMP 2,126 0.005 0.029 0.000 0.000 0.000
GROWTH 2,126 0.012 0.568 −0.105 −0.025 0.059
LAG_GW_ACQ 2,126 0.462 0.499 0.000 0.000 1.000
CEO_CHANGE 2,126 0.135 0.341 0.000 0.000 0.000
CFO_CHANGE 2,126 0.161 0.367 0.000 0.000 0.000
RESTRUCTURE 2,126 0.236 0.425 0.000 0.000 0.000
GC 2,126 0.029 0.167 0.000 0.000 0.000
IMP_AMT 2,126 0.209 0.363 0.000 0.000 0.272
AR_FEES 2,126 0.340 1.853 0.000 0.017 0.081
TAX_FEES 2,126 0.214 1.053 0.000 0.089 0.089
OTHER_FEES 2,126 0.042 0.325 0.000 0.004 0.004
AR_FEE_RATIO 2,126 0.058 0.083 0.000 0.086 0.086
TAX_FEE_RATIO 2,126 0.068 0.081 0.000 0.112 0.112
OTHER_FEE_RATIO 2,126 0.018 0.059 0.000 0.003 0.003
Note: This table presents the descriptive statistics for the full sample of observations.
companies to have experienced a loss during the year, have lower ROA, have a greater amount of good-
will and have market values that suggest that goodwill is more impaired, have stock returns that are Sample
lower, and have a BIGN auditor. Also, impairment companies in the sample have an SD of stock differences
between non
returns that is higher than nonimpairment companies and are more likely to have recorded non- imparment
intangible impairments, have had an acquisition during the year involving goodwill, and have experi- and impaired
companies
enced executive turnover and restructuring.23 The two subsamples are similar in terms of number of
business segments and revenue growth.
Multiple regression analyses

Table 4 presents the results of the estimations of model (1). Column (1) presents the results of an
analysis that includes the natural log of audit fees as well as the variable of interest, the natural log
of nonaudit fees (LN_NONAUDIT). The negative and significant coefficient on LN_NONAUDIT
23. Note that IMP_AMT when IMP = 0 has a mean of 0.001. This is due to the existence of some immaterial impairments.
Please see section 5 for our robustness tests related to materiality.

TABLE 3
Comparative descriptive statistics
IMP = 0 IMP = 1
Variable N Mean N Mean Difference t-statistics
NONAUDIT_FEES 1,466 0.685 660 0.399 0.286 2.474**

AUDIT_FEES 1,466 2.854 660 2.234 0.620 1.444
FEE_RATIO 1,466 0.154 660 0.126 0.028 4.916***
TOTAL_FEES 1,466 3.539 660 2.633 0.906 1.686*
BIGN 1,466 0.501 660 0.583 −0.082 −3.529***
MKVALT 1,466 2,981.934 660 985.460 1,996.474 4.291***
IMP_PCT 1,466 0.088 660 0.199 −0.111 −16.833***
GDWL_PCT 1,466 0.090 660 0.169 −0.079 −9.959***
LOSS 1,466 0.284 660 0.736 −0.452 −21.705***
LEVERAGE 1,466 0.979 660 1.125 −0.146 −1.798*
ROA 1,466 −0.004 660 −0.073 0.069 12.161***
GW_ACQ 1,466 0.332 660 0.456 −0.124 −5.391***
EBITDA_CHANGE 1,466 −0.011 660 −0.382 0.371 6.707***
SEGMENTS 1,466 1.173 660 1.198 −0.025 −0.666
ANN_RETURN 1,466 0.081 660 −0.306 0.387 14.633***
STDEV 1,466 0.116 660 0.188 −0.072 −14.951***
OTHER_IMP 1,466 0.002 660 0.013 −0.011 −5.870***
GROWTH 1,466 0.027 660 −0.022 0.049 1.589
LAG_GW_ACQ 1,466 0.430 660 0.535 −0.105 −4.503***
CEO_CHANGE 1,466 0.113 660 0.183 −0.070 −4.119***
CFO_CHANGE 1,466 0.144 660 0.198 −0.054 −3.024***
RESTRUCTURE 1,466 0.177 660 0.367 −0.190 −8.940***
GC 1,466 0.009 660 0.073 −0.064 −6.135***
IMP_AMT 1,466 0.001 660 0.669 −0.668 −50.145***
AR_FEES 1,466 0.412 660 0.180 0.232 3.390***
TAX_FEES 1,466 0.227 660 0.183 0.044 0.967
OTHER_FEES 1,466 0.046 660 0.036 0.01 0.662
AR_FEE_RATIO 1,466 0.064 660 0.044 0.02 5.664***
TAX_FEE_RATIO 1,466 0.069 660 0.066 0.003 0.824
OTHER_FEE_RATIO 1,466 0.020 660 0.015 0.005 1.845*
Notes: This table provides the descriptive comparison for those observations where IMP = 0 (no material goodwill
impairment recorded) and observations where IMP = 1 (material goodwill impairment recorded). The last column
presents the t-statistics of the difference between the two subsamples. All variables are defined in the Appendix.
*, **, and *** indicate significance at the 0.10, 0.05, and 0.01 levels, respectively (based on two-tailed tests).
(p < 0.01) indicates that nonaudit fees are inversely related to a company’s likelihood of recording a
goodwill impairment. Using average marginal effects, the coefficient suggests that a one SD Results
increase in LN_NONAUDIT corresponds to a reduction in impairment likelihood of approxi-

mately 4.4 percent, or approximately 14.2 percent of the impairment rate in our sample (which is
31 percent).24 In contrast to the finding for nonaudit fees, there is a positive and significant rela-
tion between audit fees and goodwill impairments (p < 0.01). This result is similar to the findings
24. Economic significance was calculated by obtaining the average marginal effect of LN_NONAUDIT (−0.0959) and
multiplying it by the standard deviation (0.456, untabulated). Because nonaudit fees are somewhat skewed, we also
assess the economic effect when moving from the 25th percentile to the 75th percentile of LN_NONAUDIT. We
find that this change (0.19) is associated with a 5.9 percent decrease in impairment relative to the unconditional
sample mean (31 percent).

TABLE 4
Impairment likelihood analysis
(1) (2)
Variables (+, −) IMP IMP
LN_NONAUDIT ? −0.7421***
(−2.700)
LN_AUDITFEES + 0.7184***
(2.582)
FEE_RATIO ? −1.4024**
(−2.420)
LN_TOTAL_FEES + 0.2397
(1.273)
BIGN + 0.1829 0.2169
(1.002) (1.215)
LN_MKVALT − −0.0206 0.0018
(−0.237) (0.021)
IMP_PCT + 4.6578*** 4.5081***
(5.924) (5.792)
GDWL_PCT + 1.5202** 1.5534**
(2.388) (2.409)
LOSS + 1.0293*** 1.0478***
(6.080) (6.212)
LEVERAGE + 0.0182 0.0208
(0.317) (0.366)
ROA − −0.8211 −0.7296
(−0.725) (−0.653)
GW_ACQ ? 0.4439*** 0.4613***
(3.061) (3.189)
EBITDA_CHANGE − −0.2538** −0.2690**
(−2.104) (−2.197)
LN_SEGMENTS ? −0.2928 −0.2769
(−1.322) (−1.264)
ANN_RETURN − −0.9754*** −1.0055***
(−2.938) (−2.994)
STDEV + 2.9680*** 2.9267***
(3.837) (3.820)
OTHER_IMP + 3.0503 3.0909
(0.754) (0.746)
GROWTH − −0.0340 −0.0482
(−0.369) (−0.528)
LAG_GW_ACQ ? 0.0491 0.0450
(0.376) (0.344)
CEO_CHANGE + 0.3408* 0.3319*
(1.789) (1.739)
CFO_CHANGE + −0.1886 −0.1911
(−1.039) (−1.060)
RESTRUCTURE + 0.3151* 0.3749**
(1.790) (2.158)
GC + 0.5688 0.5471
(1.107) (1.056)
Industry fixed effects Included Included
(The table is continued on the next page.)

TABLE 4 (continued)
(1) (2)
Variables (+, −) IMP IMP
Year fixed effects Included Included

Observations 2,126 2,126
Pseudo R2 0.342 0.342
Area under ROC 0.871 0.870
Notes: This table presents the results of the estimations of model (1). All variables are defined in the
Appendix. Year- and industry-specific intercepts are not reported for brevity. Cluster (company) robust
z-statistics are presented in parentheses below each coefficient. *, **, and *** indicate significance at the
0.10, 0.05, and 0.01 levels, respectively (based on two-tailed tests). Bold text indicates variables of interest.
of Jarva (2014), who finds that companies that write off goodwill pay higher audit fees. 25
Column (2) presents a second estimation of model (1). In this regression, the nonaudit fees
and audit fees variables are replaced with FEE_RATIO and LN_TOTALFEES. The results of this
estimation provide similar findings to those in column (1). Clients’ total fees are not significantly asso- Results
ciated with goodwill impairments; however, as the percentage of those fees that are related to non-
audit services increases, the likelihood of recording a goodwill impairment significantly decreases
(p < 0.05). Using average marginal effects, the coefficient suggests that a one SD increase in
FEE_RATIO corresponds to a reduction in impairment likelihood of approximately 2.3 percent, or
approximately 7.6 percent of the impairment rate in our sample. In each column, the coefficients on
control variables are generally consistent with expectations and prior research. Taken together, these
results indicate that goodwill impairment is less likely given greater nonaudit fees.
Counterfactual validity
As discussed earlier, testing independence requires a sample of observations where the likelihood of
a specific outcome is similar across observations (i.e., an appropriate counterfactual). This
proper identification allows researchers to then examine how that outcome varies across specific
characteristics, such as nonaudit fees. Because establishing an appropriate counterfactual is
essential to obtaining reliable inferences for a test of auditor independence, we further assess
the validity of our sample composition and consider several alternative approaches to our sam-
ple construction in this section.
We first compare the impairment rate for companies with a market-to-book below one to those
with a market-to-book above one. We find that the impairment rate for company-year observations
in our sample, all of which have two consecutive years with market-to-book below one, is 31.0 per-
cent (with 57.3 percent of these companies impairing at some point during their time in our sample),
while the impairment rate for those firms dropped from the final sample for having a market-to-book
greater than one is only 8.9 percent.26 This significant difference in impairment rates between our
sample observations and those not included in our sample is consistent with our contention that we
have identified a sample of likely impairers.
25. Although the opposing findings for nonaudit fees and audit fees may at first seem contradictory, it is important to
note that each effect is interpreted by holding the other variables constant, not jointly. These results are consistent
with traditional investor fee arguments noted by the AICPA (2004) and the findings of Higgs and Skantz (2006)
which, taken together, suggest that investors value high audit fees because they are related to either (i) an audit of
higher quality or (ii) an audit that requires more work, and are concerned with nonaudit fees because the related
additional work is seen as directly contributing to the firm’s profitability without providing any increase in audit
quality.
26. The nonsample impairment rate further drops to 6.2 percent if we exclude all observations with a market-to-book
less than one in the current year.

Further sample restrictions

We acknowledge that our primary sample imposes restrictions to identify likely counterfactuals.
However, we take two approaches to further limit our sample to those observations that are most
likely in need of an impairment. First, we restrict our sample to include only those 1,429 observa-
tions that impair goodwill at some point during our sample window (637 of which record impair-
ments in the current year). Second, we limit the sample even further by requiring all observations
to impair goodwill in either the current year or in one of the subsequent three years (883 observa-
tions, of which 551 record a goodwill impairment in the current year). In each case, we expect
that these additional sample limitations provide an even stronger indication that the company
likely needed to impair goodwill in the current year. We present the results using these more
restricted samples in Table 5. As shown, the results for each of these samples are consistent with
our primary findings. Specifically, we find that the coefficient of interest in each estimation is
negative and highly statistically significant (p < 0.01 in all columns). These findings indicate
that, among companies that record an impairment at some point, higher nonaudit fees are associated
with a delay in recognition of that impairment.
Alternative samples
In our primary sample, we use an investor-based approach to identify counterfactual observations.
Although using a market-to-book less than one is consistent with the threshold suggested by practi-
tioners, industry participants, and regulators regarding what is a reliable external signal of realized
impairment (Fox 2008; Harrington et al. 2012; Tergesen 2002), it is not the only way to identify a
potential sample. In this section, we use two additional approaches to identify alternative samples.
We first use a regulator-based approach. More specifically, we use the Audit Analytics Comment
Letter database and obtain all company-years receiving a 10-K comment letter from the SEC with
TABLE 5
Impairment likelihood using alternative sample thresholds
(1) (2) (3) (4)

Variables (+, −) IMP IMP IMP IMP
LN_NONAUDIT ? −0.7681*** −1.0451***

(−2.797) (−2.991)
LN_AUDITFEES + 0.3857 0.5937*
(1.463) (1.776)
FEE_RATIO ? −1.8050*** −2.3828***
(−2.888) (−3.130)
LN_TOTALFEES + −0.0947 −0.0474
(−0.527) (−0.216)
Controls Included Included Included Included
Industry fixed effects Included Included Included Included
Year fixed effects Included Included Included Included
Observations 1,429 1,429 883 883
Pseudo R2 0.271 0.273 0.269 0.272
Area under ROC 0.832 0.833 0.831 0.833
Notes: This table presents the results of the estimations of model (1) on the subsamples of (i) initial sample
observations that impair at some point during our sample window (columns (1) and (2)) and (ii) initial sample
observations that impair between years t and t + 3, inclusive (columns (3) and (4)). All variables are defined in
the Appendix. Additional controls and year- and industry-specific intercepts are not reported for brevity. Cluster
(company) robust z-statistics are presented in parentheses below each coefficient. * and *** indicate significance
at the 0.10 and 0.01 levels, respectively (based on two-tailed tests). Bold text indicates variables of interest.

“PPE Issues—Intangible assets and goodwill” (i.e., Audit Analytics CL Key 208). Although this
classification is not definitive evidence that a goodwill impairment was needed, we suggest that the
SEC’s demand for further discussion around intangible assets and goodwill indicates that there were
concerns with the accounting decisions made. We then reestimate model (1) on the 4,736 company-
years that either recorded a goodwill impairment (2,711 observations) or were identified as subse-
quently receiving a goodwill-related comment letter (2,025 observations). These results are presented
in panel A of Table 6.
As shown in columns (1) and (2), we find a negative and significant association between impair-
ments and both LN_NONAUDIT (p < 0.05) and FEE_RATIO (p < 0.01). We also restrict this alter-
native sample similarly to our primary sample by limiting it to those 3,857 observations that record
an impairment at some point during the sample period (2,702 of which record a goodwill impairment
in the current year) (columns (3) and (4)) and to the 3,037 observations recording an impairment
within the subsequent three years (2,440 of which record a goodwill impairment in the current year)
(columns (5) and (6)). In each of these restricted samples, we continue to find significantly negative
coefficients on our variables of interest (p < 0.05 and p < 0.01 on LN_NONAUDIT and p < 0.01
and p < 0.01 on FEE_RATIO).
Given that our main analyses display a strong ability to correctly discriminate between impairers
and nonimpairers, our second alternative sample uses a financial statement–based approach (i.e., an
impairment prediction model) to identify sample observations. The prediction-based sample is
obtained using an approach similar in spirit to Shu’s (2000) auditor mismatch technique whereby we
use estimated probabilities to identify observations that “should have” received treatment. More spe-
cifically, we use model (1) (including LN_TOTALFEES as the only fee variable) to estimate impair-
ment likelihoods by fiscal year and use the probabilities obtained from these estimations to create
100 equal groups within each fiscal year.27 If more than half of the observations in that group impair,
we consider each observation in that group to be in need of impairment. This ensures, based on
observable characteristics, that the companies retained in our sample are those most likely to need a
goodwill impairment. Like above, we then reestimate model (1) on this sample of 1,754 observations
(1,174 of which record an impairment in the current year). The results are presented in panel B of
Table 6.
As shown in columns (1) and (2), the use of an impairment prediction model instead of the
market-to-book thresholds yields similar results. Specifically, we continue to find negative and
significant coefficients on both LN_NONAUDIT (p < 0.01) and FEE_RATIO (p < 0.05). In col-
umns (3) through (6), we again employ further sample restrictions. Our results continue to persist
when we limit the nonimpairers to the 1,516 observations that record an impairment at some point
during our sample (1,132 of which record an impairment in the current year) (p < 0.05 in each
specification) and to the 1,167 observations recording an impairment within the subsequent three
years (984 of which record a goodwill impairment in the current year) (p < 0.10 and p < 0.05
for LN_NONAUDIT and FEE_RATIO, respectively).
Taken together, the analyses in this section provide comfort that our primary sample identi-
fication approach is not driving our inferences, as our findings are not sensitive to alternative
approaches for identifying counterfactual observations.
5. Additional analyses and robustness tests

Client incentives and the effect of nonaudit fees
Our primary analyses document an average negative association between nonaudit fees and auditor
independence. Prior literature generally considers whether any association varies based on the
27. We divide the observations into 100 groups in order to ensure the buckets are narrow enough (approximately
18–24 observations per group per fiscal year) that any observations retained for the sample are those that truly are
likely impairers.

TABLE 6
Impairment likelihood using alternative samples
Panel A: Comment letter sample
(1) (2) (3) (4) (5) (6)

Variables (+, −) IMP IMP IMP IMP IMP IMP
LN_NONAUDIT ? −0.2920** −0.3538** −0.4647***

(−2.211) (−2.482) (−2.621)
LN_FEES + 0.6102*** 0.5191*** 0.5160***
(4.875) (3.830) (3.144)
FEE_RATIO ? −0.9128*** −1.1114*** −1.1308***
(−2.957) (−3.280) (−2.800)
LN_TOTAL_FEES + 0.4191*** 0.2972*** 0.2284
(4.107) (2.604) (1.615)
Controls Included Included Included Included Included Included
Industry fixed effects Included Included Included Included Included Included
Year fixed effects Included Included Included Included Included Included
Observations 4,736 4,736 3,857 3,857 3,037 3,037
Pseudo R2 0.266 0.265 0.234 0.234 0.223 0.222
Area under ROC 0.830 0.830 0.816 0.816 0.815 0.814
Panel B: Prediction-based sample
(1) (2) (3) (4) (5) (6)

LN_NONAUDIT ? −0.8411*** −0.6056** −0.6888*

(−3.815) (−2.439) (−1.954)
LN_FEES + 0.5135*** 0.1333 0.2829
(2.589) (0.586) (0.877)
FEE_RATIO ? −1.0772** −1.1721** −1.4383**
Auditor Independence and Fair Value Accounting
(−2.280) (−2.215) (−2.045)

(The table is continued on the next page.)
205

TABLE 6 (continued)
206
Panel B: Prediction-based sample
(1) (2) (3) (4) (5) (6)

LN_TOTAL_FEES + 0.0263 −0.1793 −0.0745

(0.154) (−0.894) (−0.246)
Controls Included Included Included Included Included Included
Industry fixed effects Included Included Included Included Included Included

Year fixed effects Included Included Included Included Included Included
Observations 1,754 1,754 1,516 1,516 1,167 1,167
Pseudo R2 0.132 0.127 0.137 0.137 0.145 0.144
Area under ROC 0.740 0.736 0.750 0.751 0.760 0.761
Notes: Panel A presents the results of the estimations of model (1) on the sample of observations that either impair or receive a 10-K comment letter related to
Contemporary Accounting Research
goodwill. Panel B presents the results of the estimations of model (1) on the sample of observations obtained from a prediction model. Columns (1) and (2) of each
panel examine a full sample of observations, columns (3) and (4) examine the subsample of observations that impair at some point during our sample window, and
columns (5) and (6) examine the subsample of observations that impair between years t and t + 3, inclusive. All variables are defined in the Appendix. Additional
controls and year- and industry-specific intercepts are not reported for brevity. Cluster (company) robust z-statistics are presented in parentheses below each coefficient.
*, **, and *** indicate significance at the 0.10, 0.05, and 0.01 levels, respectively (based on two-tailed tests). Bold text indicates variables of interest.
auditor’s likelihood of being influenced (e.g., recurring vs. nonrecurring fees, expected vs. unexpected
fees, relative importance of client fees). We, however, are able to use the fair value accounting setting
of goodwill to examine how client demand affects the observed relation. Because there is a high
degree of management discretion and therefore inherently more subjectivity involved, clients that are
incentivized to avoid an impairment may situationally exert any influence obtained through their non-
audit service relationship with the auditor to gain a more favorable impairment outcome (i.e., no
impairment recorded). If the previously documented association between nonaudit fees and goodwill
impairment is due to client preferences for generally avoiding the recognition of a goodwill impair-
ment, then we would expect the association to vary based on the presence of client incentives.
We explore this possibility by using four variables to proxy for conditions in which management
may lack strong incentives to avoid impairments—executive turnover, company restructuring, going-
concern opinion modification, and a small market value. The presence of each of these characteristics
increases the likelihood that the company is either going through a transition that makes them more
likely to be comfortable with, or perhaps prefer, recording an impairment (executive turnover; com-
pany restructuring), is in a financial position that prevents them from being able to credibly defend
avoiding the recording of an impairment (going concern), or has a market presence that reduces the
negative consequences of recording an impairment (small market value). We separately consider each
client incentive by adding the client incentive (i.e., INCENTIVE, which is equal to EXEC_CHANGE,
RESTRUCTURE, GC, or SMALL_CLIENT) and the interaction of the client incentive with our vari-
able of interest (i.e., LN_NONAUDIT and FEE_RATIO) to model (1). Results of these analyses are
presented in Table 7.
In each column, the variable of interest (i.e., LN_NONAUDIT and FEE_RATIO) represents
the effect of nonaudit fees for observations that did not experience one of the triggering events
and therefore have higher incentives to avoid impairment. The joint test of the variable of interest
and the interaction term (i.e., the interaction of the client incentive with LN_NONAUDIT or
FEE_RATIO) represents the effect of nonaudit fees for observations that did have an event that
reduced the incentive to avoid impairment. The interaction term itself represents a test of the dif-
ference in the association of nonaudit service fees and the likelihood of recording an impairment
between these two groups. Based on the discussion above, we expect a positive coefficient on this
variable. As shown, companies that did not experience executive turnover, restructuring, a going-
concern opinion, or high market value (i.e., those companies with a greater incentive to avoid an
impairment write down) have a lower likelihood of impairment when paying higher nonaudit fees
(p < 0.05 two-tailed and p < 0.01 two-tailed depending on the specification). However, the
likelihood of impairment consistently did not vary with the level of nonaudit fees for compa-
nies that did experience executive turnover, restructuring, going-concern opinion, or low mar-
ket value (except when LN_NONAUDIT is the variable of interest in column (3), which is
significant at p < 0.10 two-tailed).28 Furthermore, we find that the association between non-
audit fees and impairment likelihood is significantly different based upon the strength of cli-
ent incentives when LN_NONAUDIT is used as the variable of interest in the turnover
(p < 0.01 one-tailed) and going-concern (p < 0.10 one-tailed) incentive tests and when
FEE_RATIO is used in the client market value (p < 0.05 one-tailed) incentive test. Because
conventional logit coefficients on interaction terms may not provide reliable tests of whether
the interaction term is statistically significant, we also perform our analyses using the “inteff”
technique suggested by Norton et al. (2004) and present the results at the bottom of Table 7.
28. Companies with executive turnover and restructuring costs may be more likely to take a “big bath.” If these compa-
nies are using their nonaudit fee relationship to exert influence to take a “big bath,” we would expect a positive and
significant coefficient on the joint tests in columns (1) through (4) (as noted, this joint test represents the effect of
nonaudit fees for observations that did have an event that reduced the incentive to avoid impairment). We, however,
find negative coefficients on each of the joint tests, suggesting that the nonaudit fees of companies with the opportu-
nity to take “big baths” are not associated with an increased likelihood of recording an impairment.

TABLE 7
208
Client incentives cross sections
(1) (2) (3) (4) (5) (6) (7) (8)

EXEC_CHANGE RESTRUCTURE GC SMALL_CLIENT
Variables (+/−) IMP IMP IMP IMP IMP IMP IMP IMP
LN_NONAUDIT ? −1.0926*** −0.9109*** −0.7752*** −0.7306**

(−3.346) (−2.728) (−2.787) (−2.527)
LN_NAS × INCENTIVE + 0.6911*** 0.3673 13.8714* −0.0953

(2.401) (1.252) (1.357) (−0.108)
FEE_RATIO ? −1.5594** −1.4043** −1.5368*** −2.6290***
(−2.390) (−2.162) (−2.599) (−2.967)
FEE_RATIO × INCENTIVE + 0.5945 0.0077 5.4163 2.0163**
(0.520) (0.006) (1.194) (1.763)
INCENTIVE ? 0.2058 0.3739
Contemporary Accounting Research
−0.0959 −0.0189 −0.1843 −0.0420 −0.0038 −0.3259

(−0.575) (−0.087) (1.026) (1.527) (−0.289) (−0.060) (−0.018) (−1.398)
Additional controls Included Included Included Included Included Included Included Included
Industry fixed effects Included Included Included Included Included Included Included Included
Year fixed effects Included Included Included Included Included Included Included Included
Observation 2,126 2,126 2,126 2,126 2,126 2,126 2,126 2,126
Pseudo R2 0.342 0.340 0.342 0.341 0.344 0.343 0.342 0.343
Area under ROC 0.871 0.870 0.871 0.870 0.871 0.870 0.871 0.871
Linear combinations
LN_NONAUDIT + LN_NAS × INCENTIVE ? −0.4016 −0.5437* 13.0961 −0.8259
(−1.26) (−1.85) (1.28) (−0.95)
FEE_RATIO + FEE_RATIO × INCENTIVE ? −0.9649 −1.3966 3.8795 −0.6127
(−0.94) (−1.30) (0.86) (−0.82)
Norton et al. (2004) “Inteff” + 0.0874** 0.0746 0.0418 −0.0148 1.5853** 0.7821* −0.0116 0.2583*
Technique interactions (1.700) (0.489) (0.816) (−0.145) (1.775) (1.391) (−0.094) (1.631)
Notes: This table presents the results of the cross-sectional analyses based on client incentives. Columns (1) and (2) consider executive turnover, columns (3) and (4) consider
restructuring, columns (5) and (6) consider going-concern status, and columns (7) and (8) consider client market value. The dependent variable in each column is IMP. All variables are
defined in the Appendix. Additional controls and year- and industry-specific intercepts are not reported for brevity. Cluster (company) robust z-statistics are presented in parentheses
below each coefficient. *, **, and *** indicate significance at the 0.10, 0.05, and 0.01 levels, respectively (based on one-tailed tests when a prediction is made, and two-tailed
otherwise). Bold text indicates variables of interest.
As shown, our inferences are similar using this approach.29 Overall, we find that nonaudit
fees generally only relate to impairment decision outcomes when clients are more incentiv-
ized to avoid an impairment. These unique insights provide added depth into our understand-
ing of when nonaudit fees are associated with reduced auditor independence.
Nonaudit fees and the amount of impairment

Another benefit of using goodwill impairments to test the relation between nonaudit fees and
auditor independence is that goodwill impairments offer the opportunity to assess magnitude
effects as the impairment amount can range anywhere between zero and the full amount of
goodwill on the books. If nonaudit fees impair independence, as suggested by the results of the
main analyses, clients paying higher amounts of those types of fees may also record a lower
impairment amount than they would in a completely independent situation. The dependent vari-
able is IMP_AMT, which is a continuous variable equal to the amount of a company’s goodwill
impairment scaled by its pre-impairment total goodwill (Beatty and Weber 2006). Because the
amount of impairment is often zero, or nonimpairment, we use a Tobit regression model to per-
form this analysis. All control variables are the same as those used in the main analysis. A neg-
ative and significant coefficient on the variables of interest (LN_NONAUDIT or FEE_RATIO)
would provide evidence that higher nonaudit fees are associated with a lower amount of
impairment.
Table 8 presents the results of the estimations of the Tobit model. Column (1) presents the
result of an analysis including both nonaudit fees and audit fees. The negative and significant
coefficient on LN_NONAUDIT (p < 0.01) suggests that the amount of impairment declines as the
level of nonaudit fees rises. To further test this relation, column (2) presents a regression where
the nonaudit fees and audit fees variables are replaced with FEE_RATIO and LN_TOTALFEES.
Along the same lines as the results found in the test of impairment likelihood, the findings of this
analysis suggest that as the percentage of total fees that are related to nonaudit services increases,
the goodwill impairment amount decreases (p < 0.05). These results indicate an inverse relation
between the level of nonaudit fees and the amount of goodwill impairment and provides addi-
tional support for the findings in our main analyses.
Decomposing nonaudit fees into separate categories

To this point, we have considered fees as either audit or nonaudit. However, SEC fee reporting
rules require that companies separately report four types of fees: audit, audit-related, tax, and all
other—with the last three grouped together as nonaudit fees. In this section, we examine the
impact of each nonaudit category separately. In their rules regarding auditor independence, the SEC
established that “an accountant is not independent if, at any point during the audit and professional
engagement period, any audit partner, other than specialty partners, earns or receives compensation
based on selling engagements to that audit client, to provide any services, other than audit, review,
or attest services” (SEC 2003a). In offering clarification for the new fee disclosure rules in 2003,
the SEC stated that audit-related fees are “assurance and related services (e.g., due diligence ser-
vices) that traditionally are performed by the independent accountant” (SEC 2003b). These assur-
ance and related services may include “employee benefit plan audits, due diligence related to
mergers and acquisitions, accounting consultations and audits in connection with acquisitions,
internal control reviews, attest services related to financial reporting that are not required by
statute or regulation and consultation concerning financial accounting and reporting stan-
dards” (SEC 2003b). The distinct recognition of attest services is important because it sug-
gests that while services falling under tax and other are unlikely to directly benefit the audit
partner, audit partners could potentially benefit from the sale of services that are considered
29. Note that we observe a positive and statistically significant coefficient in the same three instances as using the logit
output, as well as on the going-concern interaction when FEE_RATIO is used as the variable of interest.

TABLE 8
Impairment amount analysis
(1) (2)
Variables (+, −) IMP_AMT IMP_AMT
LN_NONAUDIT ? −0.2201***
(−3.170)
LN_AUDITFEES + 0.1840***
(2.583)
FEE_RATIO ? −0.3873**
(−2.393)
LN_TOTALFEES + 0.0473
(0.983)
BIGN + 0.0672 0.0763
(1.390) (1.610)
LN_MKVALT − −0.0172 −0.0109
(−0.834) (−0.519)
IMP_PCT + 1.4512*** 1.4214***
(7.728) (7.560)
GDWL_PCT + −0.0931 −0.0853
(−0.620) (−0.564)
LOSS + 0.3538*** 0.3594***
(7.838) (7.978)
LEVERAGE + 0.0003 0.0025
(0.019) (0.187)
ROA − −0.0890 −0.0624
(−0.385) (−0.271)
GW_ACQ ? 0.0905** 0.0942**
(2.377) (2.480)
EBITDA_CHANGE − −0.0406** −0.0422**
(−2.123) (−2.150)
LN_SEGMENTS ? −0.0408 −0.0378
(−0.715) (−0.666)
ANN_RETURN − −0.2930*** −0.2999***
(−3.565) (−3.613)
STDEV + 0.9205*** 0.9123***
(4.614) (4.590)
OTHER_IMP + 0.7284 0.7281
(1.312) (1.310)
GROWTH − −0.0157 −0.0212
(−0.622) (−0.813)
LAG_GW_ACQ ? 0.0481 0.0487
(1.371) (1.383)
CEO_CHANGE + 0.1124** 0.1120**
(2.300) (2.283)
CFO_CHANGE + −0.0176 −0.0166
(−0.378) (−0.359)
RESTRUCTURE + 0.0928** 0.1095**
(2.018) (2.416)
GC + 0.1963** 0.1892**
(2.060) (1.961)
Industry fixed effects Included Included
Year fixed effects Included Included
Observations 2,126 2,126
Notes: This table presents the results of the Tobit analysis on the full sample of observations. The dependent
variable is the continuous variable IMP_AMT. All variables are defined in the Appendix. Year- and industry-
specific intercepts are not reported for brevity. Cluster (company) robust z-statistics are presented in parentheses
below each coefficient. ** and *** indicate significance at the 0.05 and 0.01 levels, respectively (based on two-
tailed tests). Bold text indicates variables of interest.

audit-related.30 This suggests that any negative effects on an auditor’s independence would be
most likely to stem from audit-related fees. In untabulated analyses, we separately consider each
type of fee and find evidence that the observed negative association between nonaudit fees and
goodwill impairments is driven by audit-related fees. We find no evidence of a negative relation
with either tax fees or other fees. These findings suggest that the negative effects associated with
auditor-provided nonaudit services are concentrated in services that are considered to be audit-
related.
Client ability to pay for nonaudit services

Although multiple regression analyses are used to control for the financial stability of each com-
pany, it is still possible that some companies simply have low cash flows relative to others and
are therefore less likely to purchase nonaudit services. If these companies are also more likely to
impair goodwill, it could affect the observed relation between nonaudit fees and impairment. To
examine this possibility, we perform several additional analyses. Because companies that have
poor cash flows are potentially less likely to be able to purchase nonaudit services and more
likely to record goodwill impairments (a value determined by expected future cash flows), we first
rerun model (1) on a subsample of firms with negative cash flows from operations in the current
year (N = 331) and on a subsample of firms with negative cash flows in both the current and sub-
sequent years (N = 101). In untabulated tests, we continue to find a significant negative associa-
tion between nonaudit fees and the likelihood of an impairment in each specification.
Because earlier tests suggest that audit-related services are the source of the negative associa-
tion, we further examine a company’s ability to pay by examining a subsample of firms with audit-
related fees above the sample median (N = 1,051). In each regression, we include an indicator for
negative cash flows from operations, along with an interaction between that variable and our vari-
able of interest. In untabulated analyses, we find that there is no statistical difference in the associa-
tion of nonaudit fees and the likelihood of impairments between firms with negative cash flows
from operations and those with positive cash flows from operations. These results hold whether we
examine all nonaudit fees together or if we separately examine audit-related fees.31 Taken together,
these findings provide some comfort that our documented results are not caused by some companies
simply having an inability to pay for nonaudit services.
Propensity score matching

In this section, we use propensity score matching to help alleviate any concerns of potential bias
in the estimated coefficients that can be caused by misspecification (nonlinearities) between the
dependent variable, the independent variable of interest, and/or the control variables (Armstrong
et al. 2010; Lawrence et al. 2011; Shipman et al. 2017). Because our variable of interest is contin-
uous, we dichotomize it based on the median level of nonaudit fees and then match observations
below the median to observations above the median.32 Matching occurs one-to-one without
30. A review of several of the largest audit firm transparency reports (each available publicly on the firm’s website)
indicates that firms often have compensation policies that are consistent with these SEC definitions. Specifically,
they indicate that nonaudit fees as a whole do not directly factor into audit partner compensation, but some note that
attestation and assurance related services can. If, as suggested by the SEC and others (e.g., Ramos and Delahanty
1999; Dey et al. 2012), the profitability of these services is much higher, they could play a dominant role relative to
the compensation received directly from audit services.
31. Across the four specifications, the only coefficient that is not significant among both positive and negative cash flow
observations is the FEE_RATIO coefficient for observations with positive cash flow when considering all nonaudit
fees together.
32. An alternative approach to avoid the clustering issue is to use a matching process similar to Lennox and Pittman
(2010) and Francis et al. (2013) where the dependent variable in the match is the same as the dependent variable in
the main model. This approach ensures that companies in the matched subsamples are similar on all observable
characteristics, while still allowing for variation in the variable of interest (LN_NONAUDIT or FEE_RATIO). In
untabulated analyses, we use this approach and our inferences are unchanged.

replacement, within a maximum caliper distance of 3 percent, and includes all control variables from
model (1). Untabulated comparisons of our resulting matched sample suggest that the balance
between samples is greatly improved in each setting. Untabulated regression results continue to pro-
vide statistically significant coefficients on the variable of interest in both the LN_NONAUDIT and
the FEE_RATIO estimations, further suggesting that nonaudit fees have a negative relation with the
likelihood of recording a material goodwill impairment.
Materiality of impairment
Throughout this study, we define IMP as a material impairment in order to reduce potential statistical
noise that may be introduced by immaterial goodwill write-offs. To ensure that our results are not
influenced by this decision, we perform two additional analyses. First, we eliminate the materiality
requirement when classifying companies as recording an impairment or not (i.e., immaterial impair-
ments are now in the IMP = 1 group rather than the IMP = 0 group). Second, we exclude observa-
tions with an immaterial impairment and analyze only those observations with a material impairment
or no impairment. In untabulated tests, we find that our results remain qualitatively unchanged using
these alternatives. Thus, the results do not appear to be driven by the decision to examine material
goodwill impairments.
6. Conclusion
Prior to concluding, we note some potential limitations of our study. First, while we utilize several Limitations
of the
techniques to identify counterfactual observations in our setting, we cannot conclusively identify paper:
observations that should have recorded an impairment but failed to do so. Second, we acknowl-
edge that while our results should generalize to companies with a material amount of goodwill on
their books, not all companies have goodwill and experience the goodwill impairment decision.
Nonetheless, we believe that our results provide meaningful insights into the potential association
between nonaudit fees and other fair value assets. Third, we include numerous control variables
in our models, but as in any empirical study, the possibility exists that we have not sufficiently
controlled for all necessary company and market effects (e.g., unobservable aspects of a comp-
any’s corporate governance structure). Why we did this stydy?
Notwithstanding these limitations, this study examines the association between nonaudit fees
paid and the likelihood of recording a goodwill impairment. Understanding this association is
important given the significant challenges that auditors face in auditing goodwill, the PCAOB’s
inspection results that reveal that testing goodwill for impairment is a common audit deficiency,
and the fact that the PCAOB has issued several enforcement actions that cite violations in
auditing accounting estimates, including goodwill (issues that have led the PCAOB to propose a
new auditing standard aimed at improving the auditor’s testing of goodwill and other estimates).
Each of these factors suggests that the goodwill impairment decision may present opportunities
for auditors to be influenced by their financial ties to a client. In addition, the use of goodwill
impairments allows us to comment on potential independence issues in a broad fair value setting,
which is valuable given the increase in fair value accounting over the past few decades.
Using a sample of companies with material goodwill and a high probability of impairment
based on capital market indicators, we find a negative relation between nonaudit fees and the like-
lihood of recording a goodwill impairment. These results are consistent with higher levels of non-
audit fees being associated with compromised independence in accounting for goodwill.
Additional tests suggest that our findings are not the product of our primary sample construction
decisions and that the observed negative effects of nonaudit fees on auditor independence are
driven by clients who are most incentivized to avoid an impairment. Overall, our results provide
consistent evidence that nonaudit services have a significant and negative association with good-
will impairment likelihood.
The results of this paper provide valuable insights to regulators and academics. Our results
using the goodwill setting reveal possible independence concerns surrounding this important

account. In addition, our findings highlight that a lack of auditor independence may have greater
consequences in fair value accounting settings due to the substantial judgment involved. The vari-
ation documented in our cross-sectional examination of client incentives further underscores these
independence concerns because it suggests that clients situationally exert their influence over
external auditors. The findings of this paper also offer some validation for the change in inde-
pendence standards that regulators imposed in the early 2000s. Importantly, however, our
results suggest that even though the passage of SOX limited the nonaudit services that clients
can purchase from their auditor, post-SOX levels of nonaudit fees may still have an impact on
auditor independence.
Appendix
Variable descriptions
Variable Variable definition
ANN_RETURN Company’s buy and hold stock return over the current year
AR_FEE_RATIO Sum of audit-related fees divided by total fees paid to current fiscal year
auditor
AUDIT_FEES Sum of audit fees (in millions) paid to current fiscal year auditor
BIGN Indicator variable equal to one if the company is audited by a Big N firm, and
zero otherwise
CEO_CHANGE Indicator variable equal to one if the company experienced turnover of the
CEO in the current year, and zero otherwise
CFO_CHANGE Indicator variable equal to one if the company experienced turnover of the
CFO in the current year, and zero otherwise
EBITDA_CHANGE Change in a company’s EBITDA from prior period scaled by its market value
of equity
EXEC_CHANGE Indicator variable equal to one if the company experienced either CEO or CFO
turnover in the current year, and zero otherwise
FEE_RATIO Sum of nonaudit fees divided by total fees paid to current fiscal year auditor
GC Indicator variable equal to one if the company received a going-concern
opinion modification in the current year, and zero otherwise
GDWL_PCT Pre-impairment percentage of a company’s assets that is composed of goodwill
GROWTH Current year total revenue less prior year total revenue divided by prior year
total revenue
GW_ACQ Indicator variable equal to one if the company performed an acquisition that
increased goodwill during the current year, and zero otherwise
IMP Indicator variable equal to one if the company recorded a material goodwill
impairment during the fiscal year (defined as a goodwill impairment greater
than 0.5% of revenues), and zero otherwise
IMP_AMT Continuous variable equal to the amount of a company’s goodwill impairment
divided by its pre-impairment total goodwill
IMP_PCT Percentage that a company’s market value of assets is below book value of
assets
INCENTIVE Variable taking a value equal to EXEC_CHANGE, RESTRUCTURE, GC, or
SMALL_CLIENT, depending on model specification
IND_FE Indicator variables for each 2-digit SIC classification
LAG_GW_ACQ Indicator variable equal to one if the company performed an acquisition that
increased goodwill during the previous year, and zero otherwise
(The Appendix is continued on the next page.)

Appendix (continued)
Variable Variable definition
LEVERAGE Total short- and long-term interest bearing debt divided by pre-impairment
book value of equity
LN_AUDITFEES Natural log of the sum of 1 + audit fees (in millions) paid to current fiscal year
auditor
LN_ARFEES Natural log of the sum of 1 + audit-related fees (in millions) paid to current
fiscal year auditor
LN_MKVALT Natural log of the company’s market value of equity
LN_NONAUDIT Natural log of the sum of 1 + nonaudit fees (in millions) paid to current fiscal
year auditor
LN_OTHERFEES Natural log of the sum of 1 + “other” nonaudit fees (in millions) paid to current
fiscal year auditor
LN_SEGMENTS Natural log of the company’s number of segments
LN_TAXFEES Natural log of the sum of 1 + tax fees (in millions) paid to current fiscal year
auditor
LN_TOTALFEES Natural log of the sum of 1 + total fees (in millions) paid to current fiscal year
auditor
LOSS Indicator variable equal to one if the company suffered a pre-impairment loss
for the fiscal year, and zero otherwise
MKVALT Company’s market value of equity (in millions)
NEG_CFO Indicator variable equal to one if the company experienced negative cash flows
from operations in the current fiscal year, and zero otherwise
NONAUDIT_FEES Sum of nonaudit fees (in millions) paid to current fiscal year auditor
OTHER_FEE_RATIO Sum of “other” nonaudit fees divided by total fees paid to current fiscal year
auditor
OTHER_IMP Continuous variable equal to the pre-tax amount of nonintangible assets written
off divided by pre-impairment total assets
RESTRUCTURE Indicator variable equal to one if the company incurred restructuring costs in
the current year, and zero otherwise
ROA Pre-impairment net income divided by average total assets for the year
SEGMENTS Company’s number of segments
SMALL_CLIENT Indicator variable equal to one if the company was below the sample median
of market value of equity in the current year, and zero otherwise
STDEV Standard deviation of a company’s stock returns over the current year
TAX_FEE_RATIO Sum of tax fees divided by total fees paid to current fiscal year auditor
TOTAL_FEES Sum of all fees (in millions) paid to current fiscal year auditor
YEAR_FE Indicator variables for each COMPUSTAT fiscal year
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Auditor Independence and Fair Value Accounting:

An Examination of Nonaudit Fees and Goodwill Impairments*

JOSEPH V. CARCELLO, University of Tennessee

TERRY L. NEAL, University of Tennessee†

LAUREN C. REID, Wake Forest University

JONATHAN E. SHIPMAN, University of Arkansas

Indépendance de l’auditeur et comptabilité à la juste valeur :

CAR Vol. 37 No. 1 (Spring 2020)

CAR Vol. 37 No. 1 (Spring 2020)

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CAR Vol. 37 No. 1 (Spring 2020)

Nonaudit services and auditor independence

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Nonaudit fees and goodwill impairments

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3. Research methodology and sample selection

IMPit = β0 + β1 ðLN_NONAUDIT it or FEE_RATIOit Þ + βx CONTROLSit + IND_FE + YEAR_FE + εit , ð1Þ

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Variable N Mean SD p(25) Median p(75)

IMP 2,126 0.310 0.463 0.000 0.000 1.000

Multiple regression analyses

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Variable N Mean N Mean Difference t-statistics

NONAUDIT_FEES 1,466 0.685 660 0.399 0.286 2.474**

increase in LN_NONAUDIT corresponds to a reduction in impairment likelihood of approxi-

CAR Vol. 37 No. 1 (Spring 2020)

(The table is continued on the next page.)

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Year ﬁxed effects Included Included

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Further sample restrictions

(1) (2) (3) (4)

LN_NONAUDIT ? −0.7681*** −1.0451***

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5. Additional analyses and robustness tests

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Panel A: Comment letter sample

(1) (2) (3) (4) (5) (6)

LN_NONAUDIT ? −0.2920** −0.3538** −0.4647***

Panel B: Prediction-based sample

(1) (2) (3) (4) (5) (6)

LN_NONAUDIT ? −0.8411*** −0.6056** −0.6888*

(−2.280) (−2.215) (−2.045)

CAR Vol. 37 No. 1 (Spring 2020)

Panel B: Prediction-based sample

(1) (2) (3) (4) (5) (6)

LN_TOTAL_FEES + 0.0263 −0.1793 −0.0745

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Client incentives cross sections

(1) (2) (3) (4) (5) (6) (7) (8)

LN_NONAUDIT ? −1.0926*** −0.9109*** −0.7752*** −0.7306**

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−0.0959 −0.0189 −0.1843 −0.0420 −0.0038 −0.3259

Nonaudit fees and the amount of impairment

Decomposing nonaudit fees into separate categories

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Client ability to pay for nonaudit services

Propensity score matching

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LN_NONAUDIT ? −0.7681* −1.0451*

LN_NONAUDIT ? −0.2920 −0.3538 −0.4647***

LN_NONAUDIT ? −0.8411* −0.6056 −0.6888*

LN_NONAUDIT ? −1.0926* −0.9109* −0.7752* −0.7306