THE ACCOUNTING REVIEW
Vol. 77
Supplement 2002 pp. 107–114

DISCUSSION OF
The Relation between Auditors’
Fees for Nonaudit Services and
Earnings Management
William R. Kinney, Jr.
The University of Texas at Austin

Robert Libby
Cornell University
I. INTRODUCTION rankel et al. (2002) (hereafter FJN) present a timely paper using a new data set to test several propositions, including one suggested by the Securities and Exchange
Commission (SEC) about the relation between nonaudit fees paid by a registrant to its auditor and the registrant’s earnings quality. In this discussion we use comments from participants at The Accounting Review Conference on Quality of Earnings and our own analyses to evaluate FJN’s approach from both conceptual and operational perspectives.
We organize our discussion around a ‘‘Predictive Validity Model’’ (displayed later in
Figure 1) that shows conceptual relations between independent and dependent variables, as well as their operational measures and treatment of other causal factors. We use this model to describe and evaluate the authors’ approach, which blends complex behavioral and contractual relations with aggregate observable fee, accounting, and market price data. We hope that the discussion will encourage others to conduct additional research to address the important questions raised by both FJN and the SEC.

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II. FJN’s APPROACH
The underlying proposition examined by FJN is that the strength of the audit firm’s economic dependence on the client, or economic bond, consciously or unconsciously reduces the auditor’s independence, or willingness to resist client-induced biases in the reporting process. The lack of auditor independence results in lower earnings quality. The underlying cause (the economic bond) and the effect (lowered earnings quality) are the two theoretical constructs examined. Both are