Generalized Trust and Nonaudit Services

Synopsis

The research problem

We investigated the effect of country-level generalized trust on the demand and supply of auditor-provided nonaudit services (NAS).

Motivation

Whether NAS impairs auditor independence has been — and continues to be — a topic of intense debate among practitioners and regulators. In response, regulators worldwide are increasingly imposing restrictions on the provision of NAS, and audit firms have begun voluntarily abstaining from offering NAS to their audit clients. Nevertheless, the overall level of NAS provision varies significantly across countries, and the reasons for this variation remain unclear. The lack of evidence on the role of country-level generalized trust in explaining cross-country differences in the demand and supply of NAS motivated our study.

The test hypothesis

We hypothesized that generalized trust is associated with the level of NAS. Given competing theoretical arguments, we adopted a nondirectional hypothesis.

Target population

Our study focused on listed companies in Europe. We used a sample of 3,528 publicly listed companies in 27 European countries for the period 2011–2020. Using a European sample offered the advantage of examining firms operating under similar regulatory frameworks established by EU law.

Adopted methodology

We performed ordinary least squares regressions to test our hypothesis.

Analyses

To measure country-level generalized trust, we used data from the Integrated Values Survey. We captured NAS supply and demand using the natural logarithm of nonaudit fees and the ratio of nonaudit fees to total auditor fees.

Findings

We found a positive association between generalized trust and NAS. In additional analyses, we found that, first, the often-reported positive association between NAS and cost of capital is present only in low-trust countries, which suggests that generalized trust mitigates concerns related to the appearance of independence. Second, the effect of generalized trust on auditor-provided NAS is more pronounced in countries with low regulatory quality. Third, our main findings on the positive effect of generalized trust on auditor-provided NAS are not conditional on the strictness of NAS requirements at the country level. Fourth, the positive association between NAS and generalized trust holds only for NAS other than audit- or tax-related NAS.