The effect of non-audit fees on interest payments classification shifting: Does internal governance and firm financial well-being matter?

Purpose– This study examines the effect of non-audit fees (NAF) provisions on interest payments classification shifting. In addition, we investigate to what extent the NAF economic bonding and interest payments classification shifting is contingent on internal governance and firm financial well-being.
Design/methodology/approach – This study employed Probit regression using a sample of UK non-financial firms indexed in FT UK (500) over the period from 2009 to 2017.
Findings – We find evidence that the economic bonding of NAF between external auditors and their clients is more likely to encourage managers in UK firms to manipulate operating cash flows through interest payment classification shifting. In addition, and interestingly, our results evince that classification-shifting may be the less costly and the soft choice of managers in firms with strong governance and charging higher NAF. Furthermore, we show that financially distressed firms associated with their auditors in purchasing non-audit services are more prone to attempting to manipulate and engage in interest payments classification-shifting. Our result did not provide a significant effect of external auditor tenure on the interest payments classification shifting.
Originality/value – This study motivated by the UK’s Financial Reporting Council regulators' pressure on the Big 4 audit firms to move more audit time into main auditing activities, reduce cross-selling to audit clients, and separate their audit practices by 2024. Overall, we provide new evidence that directs a close spotlight on the threats of NAF potentially useful to regulators, shareholders, and investors.