Examines whether the provision of audit clients with nonaudit services result in knowledge spillovers and audit production efficiencies that could produce economic rents for the auditor. Demonstration of the comparability of the research sample with prior studies; Data set compiled from the participating firm's internal billing records.

Previous research has shown that analysts' forecasts of quarterly earnings per share (EPS) are more accurate than those of accepted time‐series models. In addition, some previous research suggests that, on average, analysts' forecasts tend to be optimistic (i.e., biased). Two explanations for analysts' superiority have been proposed: (1) analysts use more recent information than can time‐series models and (2) analysts use forecast‐relevant information not included in the time‐series of past earnings. This paper provides evidence on a third potential source of analyst superiority: the possibility that humans can use past earnings data to predict future earnings more accurately than can mechanical time‐series models. We find that human judges do no worse than accepted time‐series models when both use the same information set: namely, the series of past EPS figures. To date, little or no research has attempted to determine why analyst bias might exist. Still, some possible reasons have been forwarded. First, pessimistic forecasts or reports may hinder future efforts of the analyst or the analyst's employer to obtain information from the company being analyzed. Second, forecast data bases may suffer a selection bias if analysts tend to stop following those firms that they perceive as performing poorly. This study proposes, and provides evidence regarding, a third possible explanation for analyst bias: the use of judgmental heuristics by analysts. Many studies have shown that human predictions are often biased because of the use of such heuristics. We present evidence that suggests this may be the case for analysts' forecasts of earnings per share. Résumé. De précédents travaux de recherche ont démontré que les prévisions des analystes relatives au bénéfice par action (BPA) trimestriel sont plus exactes que celles que permettent d'obtenir les modèles reconnus basés sur les séries chronologiques. De plus, les résultats de certains travaux de recherche laissent croire qu'en moyenne, les prévisions des analystes tendent à être optimistes (c'est‐à‐dire biaisées). Deux explications à cette supériorité ont été proposées: 1) l'information que les analystes utilisent est plus récente que celles utilisées dans les modèles fondés sur les séries chronologiques et 2) les analystes utilisent de l'information pertinente aux prévisions qui ne figure pas dans les séries chronologiques relatives aux bénéfices passes. Les auteurs attribuent à un troisième facteur potentiel cette supériorité: la possibilité pour les humains d'utiliser les données relatives aux bénéfices passés pour prédire les bénéfices futurs de façon plus précise que ne le peuvent les modèles fondés sur les séries chronologiques. Ils en viennent à la conclusion que les humains obtiennent des résultats tout aussi efficaces que les modèles chronologiques reconnus lorsqu'ils utilisent un jeu de renseignements identique, soit les données historiques relatives au BPA. Jusqu'à maintenant, peu de chercheurs, sinon aucun, ont tenté de déterminer à quoi tiendrait l'existence d'un biais chez l'analyste. Malgré tout, certaines explications possibles ont été proposées. Premièrement, les prévisions ou les rapports pessimistes peuvent faire obstacle aux efforts futurs de l'analyste ou de son employeur pour obtenir de l'information de la société faisant l'objet de l'analyse. Deuxièmement, les bases de données servant à la prévision peuvent être entachées d'un biais de sélection si les analystes ont tendance à cesser de suivre les entreprises qui leur semblent afficher une piètre performance. Les auteurs proposent et attestent une troisième explication possible du biais de l'analyste: l'utilisation de méthodes heuristiques fondées sur le jugement. De nombreuses études ont démontré que les prédictions humaines sont souvent biaisées par suite de l'utilisation de ces méthodes heuristiques. Les auteurs apportent des arguments qui permettent de croire que ce pourrait être le cas des prévisions des analystes du bénéfice par action.

[In this article, we use audit-hour and billing-rate data supplied by a large public accounting firm to address the question, "Does providing audit clients with nonaudit services result in knowledge spillovers and audit production efficiencies that could produce economic rents for the auditor?" In prior analytical work, both Simunic (1984) and Beck et al. (1988) have argued that knowledge acquired while providing nonaudit services may "spill over" to the production of the audit, and thus generate production efficiencies. If audit production efficiencies lead to cost savings that are retained in whole or in part by the auditor (rather than passed on to the client), then economic rents accrue to the auditor, creating incentives for the auditor to resolve disputes in the client's favor. Although several past studies suggest that the joint provision of audit and nonaudit services may give rise to knowledge spillovers that could lead to economic rents (Palmrose 1986; Simon 1985; Simunic 1984; Turpen 1990), they do not provide direct evidence that spillovers or rents exist, and the empirical results are mixed. For example, Abdel-khalik (1990, 320) reports that he was unable to detect interdependencies between audit and nonaudit fees, a direct contrast to the findings of Simunic and Palmrose. Further, Palmrose reports a positive relation between audit fees and the nonaudit fees paid to nonincumbent firms, a finding that weakens the argument for knowledge spillovers. Thus, as Solomon (1990, 328) points out, "... the impact of MAS (management advisory services) on audit pricing as well as who (i.e., the client or the auditor) benefits from knowledge spillovers (if they exist) remains an open and interesting question." Our empirical analysis consists of three steps. First, we demonstrate the comparability of our sample to those in prior studies by fitting prior researchers' models to our data and replicating a finding Simunic (1984) interpreted as evidence of knowledge spillovers: a positive relation between audit and nonaudit fees. Second, we use a unique data set compiled from the participating firm's internal billing records, working papers, and audit planning memos to test for a positive relation between nonaudit services and audit effort. This test is motivated by Palmrose's (1986, 410) speculation that the higher audit fees paid by clients who also purchase nonaudit services may be driven by additional audit effort. We regress audit effort on nonaudit service fees (and Palmrose's control variables), partitioning nonaudit fees into three types: tax, accounting, and other. We use three measures of audit effort: unweighted audit hours, audit hours weighted by billing rate ratios, and audit hours weighted by billing rates. We find a weakly significant, positive relation between tax services and all three audit effort measures and between accounting-related consulting services and audit hours weighted by billing-rate ratios, which suggests that additonal effort is required for audits of clients who also purchase nonaudit services. With the assumption that the demand for auditing is inelastic (Beck et al. 1988, 52-54), these results do not support the existence of audit production efficiencies from knowledge spillovers. Third, we test whether there is a positive relation between audit fees for a given level of audit effort and each of our three types of nonaudit service fees. This test is motivated by the possibility that, if the demand for auditing is elastic (Simunic 1984, 698), the observed increase in audit fees and effort could be driven by demand for more auditing by purchasers of nonaudit services (e.g., in substitution for internal control) as the result of auditors passing on cost savings from knowledge spillovers. If auditors are able to retain some of the cost savings, and thereby earn economic rents in the form of higher fees for a given level of audit effort, then our results should reveal a significant, positive relation between nonaudit and audit fees. However, we do not find a significant relation when we control for direct measures of audit effort that were not available to prior researchers. These results suggest that, although purchasers of nonaudit services pay higher audit fees than nonpurchasers, the higher fees are associated with a proportional increase in audit effort, measured in this study as unweighted and weighted audit hours. These findings are inconsistent with one interpretation of prior research: that performing nonaudit services for audit clients may provide the auditor with incentives to compromise objectivity.]

We examine the relation between auditor tenure and a firm's ability to use discretionary accruals to meet or beat analysts' earnings forecasts. We find evidence over the period 1988-2006 that firms with both short and long tenure are more likely to report levels of discretionary accruals that allow them to meet or beat earnings forecasts. These results suggest that while regulatory mandates for periodic auditor turnover have negative effects, sustained long-term auditor-client relationships may also be detrimental to audit quality. Further, although we observe a positive relation between tenure and the use of discretionary accruals to meet or beat earnings in the pre-Sarbanes-Oxley (SOX) period, we do not observe such a relation in the post-SOX period. This latter finding is consistent with regulatory reforms and heightened scrutiny of financial reporting in the post-SOX period resulting in less aggressive efforts at managing earnings by client firms and/or increased diligence on the part of auditors. These findings may not generalize to firms that are not covered by analysts, because these firms do not face the same public pressure to manage earnings in order to meet or beat expectations. © CAAA.