Do client firms manage the perception of auditor independence? : Evidence from the Swedish non‐audit service market

Purpose – The purpose of this paper is examine whether agency conflicts between controlling and minority shareholders affect firms' decisions to purchase non‐audit services (NAS). The author examines whether client firms engage separate firms for audit and non‐audit functions, especially if the expected agency costs are high. Design/methodology/approach – The sample consists of 772 firm‐year observations from Sweden where the ownership patterns are highly concentrated. The hypotheses are tested using multivariate regression analyses. Findings – Empirical findings reveal that higher levels of agency cost proxies are significantly negatively related to both absolute and relative non‐audit fees but, at the same time, are significantly positively related to the level of outside consulting services purchased from non‐incumbent auditors. Together, these findings support the view that client firms are protecting the appearance of their auditor's independence. Research limitations/implications – One cannot rule out the possibility that there are some unspecified factors unrelated to auditor independence issues that affect both client firms' purchases of NAS and the level of outside consulting services purchased from non‐incumbent auditors. Practical implications – The research findings have implications for the functioning of the audit and NAS markets. The increasing pressure on companies to improve the perception of their auditor independence by engaging separate auditors and consultants further limits the auditor choice decision. Originality/value – This is the first paper that investigates whether agency conflicts between majority and minority shareholders affect firms' decisions to purchase NAS. This is also the first paper to examine determinants of purchases of NAS from non‐incumbent audit firms.