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Auditing: A Journal of Practice & Theory American Accounting AssociationVol. 32, No. 4 DOI: 10.2308/ajpt-50532November 2013pp. 129168

Auditor Fees and Auditor IndependenceEvidence from Going Concern Reporting

Decisions in Germany

Nicole V. S. Ratzinger-Sakel

SUMMARY: This study examines the potential for non-audit services to impair auditor

independence using going concern modifications as a proxy for audit quality. While priorresearch has focused primarily on Anglo-Saxon environments, this study focuses on

Germany because of the countrys unique reporting attributes and lower litigation risk

when compared to Anglo-Saxon settings. Based on a sample of financially stressed

manufacturing companies during the period 20052009, the results do not suggest that

German auditors are less independent when the level of non-audit fees is high. However,

there is some evidence that Big 4 audit firms are less likely than their non-Big 4

counterparts to issue a going concern emphasis-of-matter paragraph for engagements

characterized by both relatively high levels of non-audit fees and financial stress.

Keywords: auditor independence; auditor reporting; non-audit fees; audit fees;

Germany.

INTRODUCTION

The independence of auditors should [. . .] be the bedrock of the audit environment.

European Commission (EC 2010,3)

One potential threat to auditor independence, and one that attracts continuous attention from

both regulators and audit researchers, is the provision of non-audit services to audit

clients. Although globally recognized for some time, this concern has recently come to a

head at the European level. In the Green Paper Audit Quality: Lessons from the Crisis, the

European Commission (EC 2010)questioned whether the provision of non-audit services to audit

Nicole V. S. Ratzinger-Sakel is an Assistant Professor at Ulm University.

I gratefully acknowledge the helpful comments and suggestions received from Sophie Audousset-Coulier, Ilias

Basioudis, and W. Robert Knechel. I also thank the participants of the 2011 AFC Congress held in Montpellier, France,and the 6th EARNet Symposium 2011 held in Bergen, Norway, for their comments on earlier versions of this paper.Finally, I thank the two anonymous reviewers for their extremely valuable comments and insight.

Editors note: Accepted by W. Robert Knechel.

Submitted: September 2011Accepted: June 2013

Published Online: June 2013

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clients should be prohibited due to the impairment of auditor independence. In November 2011,

after an open consultation on its recommendations, the Green Paper culminated in a proposed

Regulation of the European Parliament and of the Council on Specific Requirements Regarding

Statutory Audit of Public-Interested Entities(EC 2011). Article 10 of this proposal prohibits the

provision of non-audit services for statutory auditors or audit firms carrying out statutory audit of

public-interested entities under certain circumstances(EC 2011).

In spite of these regulatory initiatives, there is very little empirical evidence to support

regulators concerns in the European context. Further, international evidence on the issue is

inconclusive. Vanstraelen (2002), examining the Belgian setting, provides limited empirical

evidence on whether the fees related to an auditors decision to issue a going concern opinion

(GCO) might impair auditor independence. In Vanstraelens and similar studies of the Belgian

setting (i.e., Gaeremynck and Willekens 2003), most of the companies are privately held. Apart

from this body of research, most available empirical evidence comes from the Anglo-Saxon

environment (e.g.,Craswell 1999; Sharma and Sidhu 2001; DeFond et al. 2002; Geiger and Rama

2003; Basioudis et al. 2008; Callaghan et al. 2009; Griffin and Lont 2010; Blay and Geiger 2012).

Although these studies have mixed results, recent U.S. evidence (e.g., Griffin and Lont 2010; Blay

and Geiger 2012)suggests that there is a negative relationship between the level of non-audit fees

and report modifications.

In this study, I contribute to the audit reporting literature by examining the German setting. I

believe this focus to be important for three reasons. First, the German setting is characterized by

unique reporting requirements reflected in theLagebericht, which is a management report, as well as

its associatedRisikobericht, which is a risk report, both of which might influence auditors reporting

decisions about going concern problems. In light of these two specific reports, results from other

settings are less generalizable to the case of Germany. Second, given the relatively high burden of

proof in civil cases in Germany(La Porta et al. 2006),the German setting has a significantly lower

litigation risk for auditors compared to Anglo-Saxon environments, which suggests a greaterpotential for impairment of auditor independence. Third, the liability cap of4 million for German

auditors of listed companies, as well as the resulting reduced liability exposure, might contribute to

concerns that German auditors may be subject to impaired independence(Irving et al. 2011).

To examine the relationship between non-audit fees and an auditors decision on whether to

report on going concern problems, I analyze a sample of financially stressed manufacturing

companies listed in Germany during the period 20052009. The results show no evidence of a

significant negative relationship between the level of non-audit fees and the likelihood that an

auditor issues a GCO. This result supports DeFond et al.s (2002) argument that market-based

incentives, such as reputational loss, are more important factors for auditor independence than is the

economic dependence created by non-audit fees. Further, the results in this paper suggest that in thepresence of non-audit fees, concerns about accuracy, professional responsibilities, and reputation

might be strong determinants of German auditors reporting behavior. However, there is some

evidence that the potential for non-audit services to impair auditor independence depends on the

type of audit firm conducting the audit (Big 4 compared to non-Big 4). If the level of non-audit fees

is relatively high, then Big 4 audit firms are less likely to issue a GCO. However, this result holds

only for highly financially stressed clients. It appears that the relatively high importance of

non-audit services in Big 4 audit engagements provides an incentive for the Big 4 auditor to keep

the client, and therefore creates an additional economic bond between the Big 4 auditor and the

client. Potential reputational concerns that are likely to offset this effect might be less apparent due

to the lower litigation risk and the liability cap in Germany. Further, there is not a significant

association between the level ofaudit fees and the likelihood that an auditor issues a GCO.

This study contributes to the audit reporting literature in at least three ways. First, the results

build on prior evidence of the impact of non-audit fees on auditor independence. There is little

130 Ratzinger-Sakel

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evidence that auditor independence is impaired by non-audit services in general, although there is

evidence of such impairment when a Big 4 firm receives relatively high non-audit fees from a client

with extreme financial distress, just the case where independence may be most necessary. One

implication of this finding is that while general concerns about accuracy, professional

responsibilities, and reputation may usually guide auditor decisions, these influences may not be

adequate in all situations given the relatively low litigation risk in Germany. Second, by using a

model that considers unique German conditions, the paper provides evidence not available from

other countries or settings. For example, results show that the content of the Risikobericht that

reports the liquidity risks of a company is positively related to the likelihood that an auditor issues a

GCO. Third, this paper adds to earlier studies on the influence of management plans on the going

concern decision by observing that German companies that confront going concern problems are

more likely to undertake operating management actions to improve their financial position.

Conversely, they are also less likely to undertake long-term strategic operating management actions

due to monetary and other constraints.

The paper is organized as follows: The second section describes relevant prior literature in the

context of the German setting related to auditor independence, non-audit fees, and going concern

reporting. The third section develops the papers hypotheses. The fourth section describes the sample

selection procedure and the model specification, and the fifth section presents the empirical results.

The sixth section presents additional and supplemental tests, while the seventh section concludes.

BACKGROUND

Non-Audit Fees, Auditor Independence, and Auditor Reporting Decisions

The international auditing literature has been studying the potential for non-audit fees to impair

auditor independence for quite some time (e.g., Mautz and Sharaf 1961; Simunic 1984; Barkess and

Simnett 1994). The rationale underlying this concern is that in addition to the economic bond

between auditor and client created by the audit itself, the provision of non-audit services to audit

clients can lead to yet another economic bond(DeAngelo 1981a; Simunic 1984),which can affect

auditors reporting decisions related to going concern issues. The research synthesis Auditor

Reporting on Going-Concern UncertaintybyCarson et al. (2013)illustrates the ongoing interest in

this topic and provides an extensive summary of the theoretical background in this area.

Specifics of the German Setting

Disclosure of Audit and Non-Audit Fees

In Germany, audit and non-audit fee information became publicly available following the EUsissuance of Article 49 of Directive 2006/43/EC (Official Journal of the European Union2006).The

German legislature implemented this Directive through the Accounting Law Reform Act

(Bilanzrechtsreformgesetz) (BilReG 2004). Effective January 1, 2005, the German Commercial

Code requires that listed companies that are operating in a regulated market for shares or bonds

must disclose both audit and non-audit fees across four categories: audits; other attestation services

to be provided in compliance with relevant independence rules; tax consultancy to be provided in

compliance with relevant independence rules; and other services (Handelsgesetzbuch [HGB],

section 285, No. 17 and section 314, paragraph 1, No. 9).1 This disclosure rule is intended to

1 Recently, the Accounting Law Modernization Act (Bilanzrechts-modernisierungsgesetz)(BilMoG 2009),whichbecame effective on May 29, 2009, extends the fee disclosure requirement to virtually all German entities subjectto statutory audits (see HGB, section 285 No. 17, section 314 paragraph 1 No. 9 and section 288 paragraph 2

sentence 3). The fee disclosure requirements due to BilReG refer to an older version of the HGB.

Auditor Fees and Auditor IndependenceGoing Concern Reporting Decisions in Germany 131



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provide financial statement users with full information about the type and level of both audit and

non-audit services. The ratio of non-audit fees to audit fees can serve as an indicator of the degree of

auditor-client (financial) independence(Bundestag 2004).

Audit Reports

In Germany, the statutory audit produces two documents. The first is the auditors report,

which accompanies the companys published financial statements. The structure and contents of the

auditors report are regulated by section 322 HGB. Pursuant to the German auditing standard IDW

PS 400which is in general compliance with ISA 700the auditors report must contain a short

description of the auditors responsibilities; a description of the client managements

responsibilities; a description of the audits subject matter, type, and scope; and the audit opinion

(Institut der Wirtschaftsprufer in Deutschland [IDW] 2009, PS 400 No. 2). Thus, the published

auditors report is standardized and consists of several paragraphs (see Appendix A). The second

document is a confidential audit report called the long-formaudit report (HGB, section 321). In

general, this document is not publicly disclosed and its contents are accessible only to the client.

Lagebericht and Risikobericht

The Lagebericht is a uniquely German reporting instrument that is required for listed

companies in Germany and for privately held companies that meet certain size criteria. The

Lagebericht is a self-contained and independent report that is not a part of the consolidated financial

statements. However, despite the formal separation between the consolidated financial statements

and the Lagebericht, these two documents are not independent of one another in terms of their

content(Baetge et al. 2011a). The purpose of the Lagebericht is to provide additional information

about a company, since its scope encompasses both the current and previous reporting periods, but

also management evaluations of the companys future development, including opportunities and

risks(Baetge et al. 2011b).In the Lageberichts Risikobericht section, management reports on the

risks to which the company is exposed (e.g., liquidity risks; for an example of a report on liquidity

risks, see Appendix B). These risks must be classified in categories and going concern risks must be

emphasized separately.

Auditors Responsibilities Regarding the Audit of the Lagebericht

The Lagebericht is subject to the audit. Auditors responsibilities in terms of the Lagebericht

are regulated in the German Auditing Standard IDW PS 350 (IDW 2009a), as listed in Table 1.

Although the disclosures in the Lagebericht are similar to the Management and Discussion Analysis(MD&A) in the United States, auditors responsibilities in these reporting instruments differ

significantly. In the United States, there is no requirement for auditors to provide assurance on the

MD&A. U.S. companies rarely retain the auditor to provide any assurance on such information,

although under PCAOB Standards the company can retain the auditor to provide some level of

assurance (AICPA 2010a; AICPA 2010b). Table 1 illustrates a German auditors responsibilities

with regard to the Lagebericht.

The potential impact of the Lagebericht on German auditors reporting behavior might be

caused by the manner in which the disclosures are made in the United States and Germany.

Financially stressed companies in the United States must provide similar disclosures as part of 10-K

filings, with some appearing merely in footnotes. As a result, such disclosures are more widely

dispersed and less easily accessible, rendering them less likely to be reliable or to be carefully

considered than disclosures presented in a separate reporting instrument such as the Lagebericht.

This observation is supported by extensive prior research on auditor decision making (Johnson and

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TA

BLE1

AuditorsResponsibilitiesw

ithRegardtotheLageberic

ht

No.of

IDW

PS350

AuditsSubject

No.of

IDW

PS350

AuditScope

No.6

AuditingwhethertheLageberichtisconsistentwithboththe

financialstatementsandthefindingsgainedfromauditing

thefinancialstatements.

No.10

Anyinformation,exceptthecorporategovernancestatement,

includedin

theLageberichtreportmustbea

udited.

Althoughforward-lookingdatacannotbeauditedinterms

ofcomplia

ncewiththefinancialstatements,

anauditof

whetherthisinformationisconsistentwiththesenseofthe

financialstatementsisrequired.

AuditingwhethertheLageberichtasawholerepresentsa

suitableviewofthecom

panysposition.

No.7

AuditingwhethertheLageberichtisconsistentwiththesingle

financialstatements,incasesinwhichthecompany

publishesasinglefinancialstatementusingIFRSfor

transparencyreasons(seeHGBsection325,paragraph2a).

No.11

Auditingwhethertheinformationreflectedbyfinancialand

nonfinancialperformanceindicatorscontributeto

representin

gasuitableviewofthecompanysposition.

No.8

Auditingwhetherthecomp

anysfuturedevelopment,and

thusthatriskandopportunitiesarecorrectlyrepresentedin

theLagebericht.Thein-d

epthexaminationofthe

companysfuturedevelopmentandthecorrespondingrisks

isalsoaconsequenceof

therequirementtoevaluatethe

managementsassessmen

tofthecompanysposition.The

examinationisbasedon

theauditedfinancialstatements

andtheLageberichtand

mustbepresentedatthe

beginningofthelong-formauditreport.Anevaluationof

boththecompanyscontinuedexistenceandthefuture

developmentisparticularlyimportant(seeHGBsection

321,paragraph1,sentence2).Inaddition,goingconcern

risksthatareidentifiedm

ustbereportedseparatelyinthe

auditorsreport(seeHGBsection322,paragraph2,

sentence3).

No.13

Theauditof

theLageberichtmusthavethesam

elevelof

accuracy(andthus,levelofassurance)astheauditof

financialstatements.

Thistable

onlyprovidesanexcerptfromIDW

PS350.




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Storey 1982; Harper et al. 1987; Hirst and Hopkins 1998; Wickens and Carswell 1995; Carswell

and Wickens 1996; Bloomfield et al. 2010; Hodge et al. 2010).Hence, the Lagebericht disclosures

may have a greater influence on auditors reporting behavior related to going concern issues.

Auditors Responsibilities Regarding Going Concern Problems

The German Auditing Standard IDW PS 400 contains two requirements that affect the

auditors responsibilities regarding going concern problems. First, if the auditor has identified going

concern problems and ensured that these have been adequately reported in the companys

Lagebericht, then he/she must highlight these risks to the companys continued existence in a

separate section of the auditors report. In this case, the auditors report shall include an emphasis-

of-matter paragraph that relates to the problems of the companys continued existence (see

Appendix A). However, such a report does not constitute a qualified audit opinion (IDW 2009b,

No. 77). Rather, the auditor is only required to issue a qualified audit opinion (IDW 2009b,No. 78)

if the company inadequately discloses impairments to the companys continued existence. In

extraordinary cases, such as the presence of several significant uncertainties, the auditor shouldconsider issuing an adverse opinion.

Litigation Risk and Consequences of an Inappropriate Auditors Report

Prior research shows that litigation rates in continental Europe are low compared to the United

States or the United Kingdom(Kinney 1994; Mueller et al. 1994; Gietzmann and Quick 1998). In

Germany, auditor liability is regulated by the German Commercial Code as follows, Whoever

intentionally or negligently violates his duties shall be obligated to compensate the listed company

and any affiliated enterprises, if affected, for the resulting damage incurred (HGB, section 323,

paragraph 1, sentence 3).La Porta et al. (2006,11) argue that countries in which the plaintiffs are

required to show that the defendant [. . .

] acted with intent or gross negligencehave a high burden

of proof.La Porta et al.s (2006, Table I in conjunction with Table II results for Germany) liability

standard index for Germany suggests that the burden of proof for litigation in which auditors are

involved is much higher compared to the United States or the United Kingdom. Furthermore, the

liability cap of4 million for German auditors of listed companies (HGB, section 323, paragraph 2,

sentence 2), as well as the resulting reduced liability exposure might also give rise to the questions

about auditor independence.

If the auditor issues an inappropriate report, i.e., issues a clean auditors report when a going

concern report would have been appropriate (referred to as a type II error) or issues a modified

auditors report (emphasis-of-matter paragraph or qualification) when a clean report would have

been appropriate (referred to as a type I error), and if they have done so with intent (HGB, section332, paragraph 1), then they could face a penalty or imprisonment of up to three years. Further, if

they additionally acted for money with the intent of enriching themselves, they may face an

increased punishment of imprisonment of up to five years (HGB, section 332, paragraph 2).

Identification of Going Concern Opinions

The sample used for this study includes all auditor reports of German manufacturing

companies that were listed at Frankfurt Stock Exchange (FWB) or other regional stock exchanges

during the period 20052009 and that have a first-time GCO. The incidence of a first-time GCO is

manually collected by reading all relevant auditors reports, which are part of the companies

annual reports.

As noted above, the structure of the auditors report is standardized. Hence, the identification of

a GCO, i.e., either an emphasis-of-matter paragraph or a qualification related to going concern

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problems, is unambiguous. However, the content and severity of a GCO can vary. Therefore, any

material in which the auditor addresses an impairment of the companys continued existence,

existing indebtedness, or the companys illiquidity is considered as a GCO. Future financing risks

and middle- and long-term impairments to a companys continued existence are also treated as

going concern problem. Information that includes general risks and/or the possibility of negativefuture developments is not treated as GCO.

Prior Evidence

Earlier studies such as those byDeFond et al. (2002), Geiger and Rama (2003), andCallaghan

et al. (2009)find no significant relationship between non-audit fees and auditors reporting behavior

for the U.S. audit market.Geiger and Rama (2003)find a positive relationship between the level of

audit fees and auditors reporting behavior, but no relationship is documented in other earlier U.S.

studies, regardless of the type of fees considered. However, the most recent U.S. research finds a

negative relationship between the level of non-audit fees and the likelihood that a company receives

a GCO(Griffin and Lont 2010; Blay and Geiger 2012).Researchers attribute the different findingsto differences in both method and time period (Griffin and Lont 2010; Blay and Geiger 2012). In

studying the Australian audit market,Wines (1994), Sharma (2001),andSharma and Sidhu (2001)

document a negative relationship between non-audit fees and auditors reporting behavior;

however,Barkess and Simnett (1994)andCraswell (1999)find no significant relationship between

non-audit fees and auditors reporting behavior. For the U.K. audit market, Lennox (1999) finds

that the level of non-audit fees is not significantly related to a GCO. In contrast, Firth (2002)and

Basioudis et al. (2008)find non-audit fees are significantly negatively related to auditors reporting

behavior in the United Kingdom. Vanstraelens (2002) study of the Belgian audit market

documents a negative relationship between the sum of operational and financial revenues, which the

author uses as a proxy for audit fees that are not publicly available for the period studied, and thelikelihood that a company receives a GCO. To conclude, the review of relevant prior literature

indicates that the findings are inconclusive.

RESEARCH HYPOTHESES

The decision of whether to report on going concern problems in the auditors report is related

to difficult negotiations between the auditor and client management. However, as noted above, there

is no evidence on the potential relationship between non-audit services and auditor reporting

decisions for financially stressed clients in Germany. Moreover, this issue has gained in relevance

in light of the current major concerns in the European Union on the potential adverse impact of

non-audit services on auditor independence. The fact that, due to the financial crisis, auditorsreports for financially stressed companies are of particular concern to the Institute of Public

Auditors in Germany (Institut der Wirtschaftsprufer in Deutschland [IDW] 2008)2 adds further

relevance to this issue.

The economic bonding argument supports a negative relationship between non-audit fees and

auditors reporting behavior. In addition, the lower litigation risk in Germany compared to

Anglo-Saxon environments also supports the argument that non-audit fees might motivate auditors

to raise fewer going concern issues in the auditors report. Finally, the fact that in Germany the

majority of companies that receive a GCO do not go bankrupt in the following year, lends support

to a negative relationship between non-audit fees and auditors reporting behavior. Hence, H1

2 The IDW again referred to this 2008 published document in 2009, suggesting that auditors reports for

financially stressed companies were of particular concern of the IDW during the period of this study.




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predicts a negative relationship between the level of non-audit fees and the likelihood that an

auditor issues a going concern report.

H1: The level of non-audit fees is negatively related to the likelihood that an auditor issues a

going concern report.

Examining the impact of non-audit fees on auditors reporting behavior without the joint

consideration of other audit attributes that might impact auditor independence, such as auditor type

and audit firm tenure, may not provide a complete picture. First, auditor type can have an impact on

auditor independence. Following DeAngelos (1981b) arguments, Big 4 audit firms have fewer

incentives to pleasethe client and, thus, might be more independent compared to non-Big 4 audit

firms. Empirical evidence supports this observation by showing that Big 4 audit firms are more

likely to issue a GCO (e.g.,Blay and Geiger 2012).In general, auditors incentives are determined

by a tradeoff between the ambition to secure audit firm reputation and to continue the auditor-client

relationship (Citron and Taffler 1992; Johnson et al. 2002). However, taken their reputational

concerns into account it can be argued that Big 4 auditors independence is less likely to be

impaired by high non-audit fees. Therefore, it is expected that Big 4 audit engagements combined

with high non-audit fees are likely to be associated with more reports on going concern issues.

Hence, H1a predicts a positive relationship between the level of non-audit fees and the likelihood

that an auditor issues a going concern report when the audit firm is a Big 4 compared to their

non-Big 4 counterparts.

H1a: The level of non-audit fees is positively related to the likelihood that a Big 4 audit firm,

compared to their non-Big 4 counterparts, issues a going concern report.

Second, economic bonding may be a consequence of a long auditor-client relationship, which

may result in familiarity and personal conflicts between the auditor and the client. Based on this

rationale, the EC has proposed mandatory audit firm rotation after six years(EC 2011). However,an increase in client and industry knowledge gained over time suggests that long-term audit firm

tenure can have a positive effect on auditor knowledge. The empirical evidence is mixed. Some

studies support the expressed concern (Levinthal and Fichman 1988; Deis and Giroux 1992;

Vanstraelen 2002) while the majority of recent studies refute this concern (Geiger and

Raghunandan 2002; Myers et al. 2003; Carey and Simnett 2006). Knechel and Vanstraelen

(2007),examining the Belgian setting in which audit firm tenure is more likely to negatively affect

audit quality, conclude that the evidence for tenure either increasing or decreasing audit quality is

weak.Gul et al. (2007)provide evidence on the joint effects of audit firm tenure and non-audit fees

for the U.S. setting by showing that non-audit fees may impair auditor independence, proxied by

discretionary accruals, when audit firm tenure is short. They argue that because of the combinationof a better understanding of the clients accounting system and an emphasis on reputation protection

rather than on profit when audit firm tenure is long, high non-audit fees are unlikely to be related

with earnings management for long auditor-client relationships. However, this evidence was

provided in an environment that significantly differs from the German setting. Therefore, and due to

the unclear impact of audit firm tenure per seon auditor independence, H1b predicts no relationship

between the level of non-audit fees and the likelihood that an auditor issues a going concern report

when audit firm tenure is long.

H1b: There is no relationship between the level of non-audit fees and the likelihood that an

auditor issues a going concern report when audit firm tenure is long.

The fundamental auditor-client relationship reflected in the audit fee itself (i.e., without any

consulting work) might also influence auditors reporting behavior. Prior pricing studies find a

positive relationship between the level of audit fees and auditors reporting behavior. This evidence

136 Ratzinger-Sakel



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suggests that GCOs require additional auditing effort and are associated with higher audit fees

(Kida 1980; Francis 1984; Francis and Simon 1987; Palmrose 1986; Beatty 1993; Bell et al. 2001;

Firth 2002). Hence, H2 predicts a positive relationship between the level of audit fees and the

likelihood that an auditor issues a going concern report.

H2: The level of audit fees is positively related to the likelihood that an auditor issues a goingconcern report.

The joint effects of audit fees and the audit attributes, auditor type and audit firm tenure, might

also influence auditors reporting behavior. First, as discussed above, a positive relationship

between both audit fees and Big 4 audit engagements and auditors reporting behavior is expected.

Consequently, H2a predicts a positive relationship between the level of audit fees and the likelihood

that an auditor issues a going concern report when the audit firm is a Big 4 compared to their

non-Big 4 counterparts.

H2a: The level of audit fees is positively related to the likelihood that a Big 4 audit firm,

compared to their non-Big 4 counterparts, issues a going concern report.Second, as discussed above the influence of audit firm tenure on auditor independence per seis

unclear while the relationship between just audit fees and auditors reporting behavior is expected to

be positive. Based on these observations and the lack of theoretical explanation why one effect

should dominate, it is likely that there is no relationship between these joint effects and auditors

reporting behavior. Hence, H2b predicts no relationship between the level of audit fees and the

likelihood that an auditor issues a going concern report when audit firm tenure is long.

H2b: There is no relationship between the level of audit fees and the likelihood that an auditor

issues a going concern report when audit firm tenure is long.

RESEARCH DESIGN

Sample

The initial sample comprises 2,145 nonfinancial companies that are listed in a regulated market

for shares or bonds for the period 20052009 (i.e., 2005460; 2006448; 2007438; 2008439;

2009360). Most of the accounting data and further company information, such as company age,

are manually collected from the companies annual reports as well as their websites and are

supplemented in rare cases by Bloomberg database. Any audit data, risk variables data, as well as

fee data are hand collected from the companies annual reports. After the identification of a GCO

the sample is restricted to those companies that receive a first-time GCO following the rationale thatthe issuance of a GCO in the subsequent year is less risky for the auditor, and that the perceived risk

of losing a disgruntled client might no longer be relevant at that point. This procedure yields a

sample of 60 companies that received an auditors report with a first-time GCO, i.e., an auditors

report including an emphasis-of-matter paragraph related to the going concern problems. At the

same time no sample company has received a qualified auditors report in terms of going concern

issues. This observation is not surprising, since management is likely to prefer to disclose

impairments to a companys continued existence in the Lagebericht. In this case, a going concern

emphasis-of-matter paragraph is the consequence of, and not a qualified opinion related to, going

concern issues.

The control sample is restricted to companies under financial stress to capture engagements that

require a significant amount of auditor judgment. The criteria for financial stress are drawn from a

survey of German public auditors (Adam 2007) in which participants assessed the relevance of

various indicators related to financial stress in the context of going concern assessments. Financially




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stressed companies are identified using one of the following criteria: (1) negative equity, (2)

negative operating cash flow, (3) negative working capital, (4) negative EBIT in the prior year, and

(5) net loss in the prior year. This procedure yields a control sample of 648 financially stressed

companies that received a clean audit opinion during the period 20052009 (referred to as the entire

control sample). However, the most recent U.S. audit reporting studies use more restrictive control

samples in which companies meet the criterion negative income,as well as negative cash flow

from operations. These studies find differing results compared to earlier U.S. audit reporting

papers. Hence, in addition to the entire control sample, a control sample of 107 companies that have

both net loss in prior year and negative cash flow from operations, but that received a clean audit

opinion over the period 20052009 is considered (referred to as the strict control sample).3

Model Specification

To test the papers hypotheses, three logistic regression models are estimated. Model (1) is the

primary model, while potential interaction effects are considered in Models (2) and (3). All models

control for fixed effects.

GCO fb0b1NAFb2AFb3SIZEb4AGEb5PROBb6CFOb7INVESTb8TENUREb9BIGFOURb10REPORTLAGb11LISTEDb12ACb13RISKb14OPERATINGb15STRATEGIC STb16STRATEGIC LTb17FE e1: 1

GCO fg0g1NAFBIGFOURg2AFBIGFOURg3NAFg4AFg5SIZEg6AGEg7PROBg8CFOg9INVESTg10TENUREg11BIGFOURg12REPORTLAGg13LISTEDg14ACg15RISKg16OPERATINGg17STRATEGIC STg18STRATEGIC LTg19FE e2:

2

GCO fu0u1NAFlg TENUREu2AFlg TENUREu3NAFu4AFu5SIZEu6AGEu7PROBu8CFOu9INVEST u10lg TENUREu11BIGFOURu12REPORTLAGu13LISTEDu14ACu15RISKu16OPERATINGu17STRATEGIC STu18STRATEGIC LTu19FE e3:

3

(See Table 2.)

The dependent variable isGCO, which takes the value of 1 if the auditors report contains a first-

time GCO. The test variables for H1 and H2 are NAFandAFin Model (1), which capture non-auditfees and audit fees, respectively. To test for the joint effects of non-audit, as well as audit fees and

auditor type, as well as audit firm tenure (H1a, H1b, H2a, H2b) the test variables in Models (2) and

(3) areNAFBIGFOUR,NAFlg_TENURE,AFBIGFOUR, andAFlg_TENURE, respectively.Further variables of interest stem from the unique German reporting requirements reflected in

the Lagebericht, as well as its associated Risikobericht. First, German auditors must evaluate the

disclosure made by management in the Lagebericht.

3 A total of 251 companies of the entire control sample report a negative cash flow and 303 companies report a net

loss in prior year. However, only 107 companies meet both criteria.

138 Ratzinger-Sakel



11/41

TABLE 2

Model Specification and Variable Measurement

Variables Definition Sign

Dependent Variable

GCO Dummy variable coded 1 if the auditors report contains a first-time

going concern emphasis-of-matter paragraph, and 0 otherwise.

Independent Variables

Test Variables

NAF Natural logarithm of non-audit fees;a AF Natural logarithm of audit fees; NAF BIGFOUR Interaction between natural logarithm of non-audit fees and dummy

variable coded 1 if the auditor is a Big 4 audit firm;

AF BIGFOUR Interaction between natural logarithm of audit fees and dummyvariable coded 1 if the auditor is a Big 4 audit firm;

NAF lg_TENURE Interaction between natural logarithm of non-audit fees and dummyvariable coded 1 if the length of the auditor-client relationship is

longer than three years;

?

AF lg_TENURE Interaction between natural logarithm of audit fees and dummyvariable coded 1 if the length of the auditor-client relationship is

longer than three years; and

?

FEERATIO BIGFOUR Interaction between the relation of non-audit to audit fees(FEERATIO) and dummy variable coded 1 if the auditor is a Big

4 audit firm.

Other Variable of Interest

RISK Dummy variable coded 1 if the Risikobericht contains a report on

liquidity risks, and 0 otherwise;

OPERATING Discrete variable representing the sum of all operating initiatives,

e.g., cost reduction activities, sales of assets, increased marketing

efforts, and product and/or process improvement for the year

under audit, scaled by its maximum value in the sample;

STRATEGIC_ST Dummy variable coded 1 if the company undertakes strategic

initiatives with short-term impact, e.g., cooperative agreements for

the year under audit, and 0 otherwise; and

STRATEGIC_LT A score from 0 to 2, scaled by its maximum value in the sample,

representing the sum of strategic initiatives with a long-term

impact, e.g., introduction of new products and report of

acquisitions in the year under audit.

Control Variables

SIZE Natural logarithm of total assets in T; AGE Age of the company measured in years; PROB Probability of bankruptcy calculated using theHopwood et al.

(1994)model;

CFO Cash flow from operating activities scaled by total assets; INVEST Short- and long-term investment securities (including cash and cash-

equivalents) scaled by total assets;

TENURE Length of auditor-client relationship measured in years; ?

lg_TENURE Dummy variable coded 1 if audit firm tenure is long, i.e., an

auditor-client relationship that is longer than three years (Knecheland Vanstraelen 2007),and 0 otherwise;

?

(continued on next page)




12/41

An explicit report on liquidity risk, which is usually part of the Risikobericht,4 might be

considered as an indication of a threat to the companys continued existence. Furthermore, it is very

likely that companies with a first-time GCO have an explicit report about liquidity risks. This

potential influence is captured by a dummy variable that takes the value of 1 if the company reports

about liquidity risks (RISK) (see Appendix C for details).

Second, Bruynseels and Willekens (2012) examine the impact of a comprehensive set of

strategic actions on an auditors going concern assessment and distinguish between managements

operational actions that focus on short-term improvement in financial performance and strategicgrowth initiatives. In Germany, that information is also part of the companies Lageberichte. For

strategic actions,Bruynseels and Willekens (2012)distinguish between those that are likely to have

an impact within the next 12 months, as an auditors GCO is an assessment of the clients continued

existence over the next 12 months, and those that have an impact over the longer term. They argue

that the implementation of operating actions, as well as strategic actions with long-term impact are

positively related with the likelihood that a company receives a GCO, while strategic actions with

short-term impact are expected to have a negative impact.5 Thus, the model includes other variables

of interest gained from the unique reports in Germany, namely operating management actions

(OPERATING), as well as strategic actions with a short-term impact (STRATEGIC_ST) and a long-

term impact (STRATEGIC_LT). To classify operating and strategic actions, Bruynseels andWillekens (2012) Strategic Score Card is used (see Appendix D for details).

Company Characteristics

Prior international studies show that company size is inversely related to the likelihood that a

company receives a GCO (e.g.,Mutchler et al. 1997; Geiger and Rama 2003; Basioudis et al. 2008)

so the model controls for company size (SIZE), measured by total assets (in T). In addition, older

companies have shown their ability to survive and, thus, are less likely to receive a GCO (Knechel

TABLE 2 (continued)

Variables Definition Sign

BIGFOUR Dummy variable coded 1 if the auditor is a Big 4 audit firm, and 0

otherwise;

REPORTLAG Number of days from companys fiscal year end to audit report day; LISTED Dummy variable coded 1 if the company is listed in one of the four

German indexes: DAX, MDAX, SDAX, and TecDAX, which are

the major German stock market indexes, and 0 otherwise;

AC Dummy variable coded 1 if an audit committee exists, and 0

otherwise; and

FE Year fixed effects.

a I use measure LN(NAF1) to avoid missing values, since this measure allows regression results even for companieswith 0 NAF.

4 In cases where companies do not have an explicit separate Risikobericht section yet include those disclosures intheir Lagebericht, the entire Lagebericht is analyzed in terms of disclosures on liquidity risks.

5 These relations are also expected for the German setting in which the auditor has to assess the going concern

assumption for at least 12 months ahead.

140 Ratzinger-Sakel



13/41

and Vanstraelen 2007).To capture this potential effect, company age (AGE), measured in years, is

added to the model. To further control for financial stress beyond the control given by the control

sample, the probability of bankruptcy (PROB), using an approach developed by Hopwood et al.

(1994), is calculated and included in the model.6 To further control for liquidity problems both

operating cash flow (CFO), measured by cash flow from operations scaled by total assets, andinvestment securities (INVEST), measured by short- and long-term investment securities (including

cash and cash equivalents) scaled by total assets, are included in the model.

Reporting Timeliness

Because auditing a financially stressed company and issuing a GCO may take more time than

does an audit of a healthier company and the issuance of a clean auditors report (e.g., Geiger and

Rama 2003; Basioudis et al. 2008), the model controls for the audit reporting lag (REPORTLAG),

measured as the number of days between a companys fiscal year-end and the audit report date.

Corporate Governance Factors

Companies that are listed on the major German stock market indexes, i.e., DAX, MDAX,

SDAX, or TecDAX must meet specific standards. In addition, only the largest and top-selling

companies tend to be listed on these indexes. Therefore, such companies are less likely to receive a

GCO than are companies that are not listed in these indexes. The model controls for this possibility

with a dummy variable (LISTED) that indicates whether the company is listed on the DAX,

MDAX, SDAX, or TecDAX indexes. The model also controls for the existence of an audit

committee. In Germany, the two-tier system implies that the supervisory board may or may not

establish an audit committee (AktG [Aktiengesetz Stock Corporation Act], section 107, paragraph

3, sentence 2).7 It is likely that the existence of an audit committee makes it easier for the auditor to

report on going concern circumstances in the auditors report. To account for the possible effect of

the presence of an audit committee, a dummy variable that captures whether an audit committee

exists (AC) is included in the model.

EMPIRICAL RESULTS

Descriptive Statistics Results

Table 3 presents descriptive statistics and illustrates the differences between the test and control

samples. The test variables NAF and AF are significantly different between the going concern

companies and the strict control sample companies, but not the full control sample. The results for

PROB show highly significant differences between the going concern companies and the control

sample companies. The going concern companies are also more likely than non-going concern

companies to have a longer reporting lag and to have implemented operating management actions.

By contrast, the going concern companies are less likely to have undertaken long-term strategic

management actions than are the non-going-concern companies. For both control samples, the

6 FollowingBasioudis et al. (2008), the value of the intercept as corrected by Geiger and Raghunandan (2001)isused.

7 The audit committees responsibilities include a recommendation related to auditor choice (AktG, section 124,paragraph 3, sentence 2) and monitoring auditor independence especially with respect to non-audit services(AktG, section 107, paragraph 3, sentence 2). If companies listed according to section 264d HGB do not have asupervisory board with one independent member and one member with financial expertise (HGB, section 324,paragraph 1, sentence 1; in conjunction with AktG, section 100, paragraph 5), they are usually required to

establish an audit committee with one independent member with financial expertise.




14/41

TA

BLE3

Descriptive

StatisticsforGoingConcern

CompaniesandControlSampleCompanies

PanelA:ContinuousVariables

GoingConcernSample

(n

60)

EntireControlSample

(n

648)

StrictControlSam

ple

(n

107)

Mean

(Std.

Dev.)

M

edian

(Range)

Mean

(Std.

Dev.)

Median

(Range)

Diff.t-test

(DiffWil.)

a

Mean

(Std.

Dev.)

Median

(Range)

Diff.t-test

(DiffWil.)

a

NAF(000

)b

217.95

60.00

617.04

5

7.50

0.323

97.63

40.00

0.042**

(529.17)

(1.00

3795.00)

(3121.39)

(

0.5042799.88)

(0.998)

(222.11)

(0.562000.00)

(0.093)*

AF(000

)b

353.85

160.00

805.36

16

5.00

0.318

171.55

100.00

0.003***

(567.971)

(20.00

2854.10)

(3489.87)

(2

1.0062000.03)

(0.612)

(182.71)

(21.001200.00)

(0.016)**

FEERATIO

0.60

0.38

0.57

0.36

0.715

0.58

0.29

0.843

(0.69)

(0.00

3.23)

(0.74)

(

0.008.05)

(0.712)

(0.78)

(0.004.47)

(0.589)

SIZE(000

000)b

4445.25

69.21

3897.40

12

4.71

0.842

234.33

50.80

0.118

(27700.00)

(3.81

214000.00)

(19500.00)

(

1.24218000.00)

(0.001)***

(892.49)

(1.247917.37)

(0.537)

PROB

0.62

0.74

0.13

0.03

0.000***

0.25

0.06

0.000***

(0.37)

(0.00

c1.00c)

(0.25)

(

0.00c1.00c)

(0.000)***

(0.33)

(0.00c1.00c)

(0.000)***

AGE

42.62

18.00

51.29

2

8.00

0.193

42.50

21.00

0.989

(50.59)

(4.00

240.00)

(49.26)

(

0.00251.00)

(0.031)**

(46.79)

(0.00250.00)

(0.606)

CFO

0.10

0.05

0.03

0.04

0.000***

0.11

0.05

0.745

(0.24)

(1.34

0.18)

(0.12)

(0.810.49)

(0.000)***

(0.13)

(0.810.00)

(0.027)**

INVEST

0.16

0.08

0.16

0.11

0.792

0.22

0.15

0.043**

(0.18)

(0.01

0.83)

(0.17)

(

0.000.94)

(0.597)

(0.21)

(0.000.94)

(0.019)**

TENURE

6.35

6.50

6.17

6.00

0.656

5.63

5.00

0.109

(3.06)

(2.00

12.00)

(2.99)

(

1.0016.00)

(0.587)

(2.62)

(2.0012.00)

(0.149)

REPORTL

AG

112.35

102

83.25

7

6.00

0.000***

91.46

78.00

0.008***

(50.73)

(28.00

272.00)

(33.88)

(1

0.00387.00)

(0.000)***

(46.20)

(34.00303.00)

(0.000)***

OPERATING

0.42

0.25

0.33

0.25

0.008***

0.29

0.25

0.004***

(0.25)

(0.00

1.00)

(0.25)

(

0.001.00)

(0.011)**

(0.27)

(0.001.00)

(0.005)***

STRATEG

IC_

LT

0.22

0.00

0.40

0.50

0.000***

0.32

0.50

0.059*

(0.32)

(0.00

1.00)

(0.36)

(

0.001.00)

(0.000)***

(0.33)

(0.001.00)

(0.037)**

(continue

donnextpage)

142 Ratzinger-Sakel



15/41

TABLE

3(continued)

PanelB:DummyVariables

GoingConcernSample

n

60

EntireControl

Sample

n

648

StrictControlSample

n

107

%

%

Diff.t-test

%

Diff.t-test

BIGFOUR

55.00%

60.65%

0.393

49.53%

0.501

LISTED

13.33%

20.22%

0.200

9.35%

0.428

AC

38.33%

43.67%

0.425

37.38%

0.904

RISK

66.67%

29.17%

0.000***

33.64%

0.000***

STRATEG

IC_

ST

46.67%

44.75%

0.776

44.86%

0.823

lg_

TENURE

75.00%

76.85%

0.746

74.77%

0.974

*,**,***

Significancelevelsat0.1,0.05,and

0.01,respectively,two-tailedtests.

a

Wilcoxon-Mann-WhitneytestisaZ-scoreapp

roximation,thetestsassumeunequalsamplevariancesandrequiresordin

al-scaledvariables.

b

Rawdata;nologarithmictransformation.

c

Rounded

value.




16/41

going concern companies are more likely than the non-going concern companies to report on

liquidity risks to which the company might be exposed in the future. Further, going concern

companies have significantly lower operating cash flows than do the entire control sample

companies. The correlation matrix (see Table 4) suggests that multicollinearity does not bias the

results; the majority of correlations are below 30 percent.

Multivariate Results

For the logistic regression results (Table 5), p-values are computed with robust standard

errors adjusted for heteroscedasticity and clustered at the firm level. The model specifications fit

the data very well, which is illustrated by the results for the Hosmer and Lemeshow (2000)

goodness-of-fit test statistic, the Receiver Operating Characteristic (ROC) curve, and the Count-

R2. The results of Model (1)8 show an insignificant relationship between the level of non-audit

fees and the likelihood that an auditor issues a GCO. Hence, there is no support for H1. This

result holds for both control samples. For the interaction effect9 with the type of auditor (Big 4

versus non-Big 4) in Model (2), the results for the strict control sample show that the NAFvariable interacts significantly with the type of auditor in explaining the likelihood that auditors

will issue a GCO when considering the Z-statistic from the ordinary regression output. However,

Norton et al. (2004)show that this output cannot be used to determine the statistical significance

in logit and probit models. Using Norton et al.s (2004) approach the statistical significance for

the interaction variableNAF BIGFOURcannot be confirmed (see Table 5, Panel D, and Figure1). However, as there is an indication that the potential compromise of auditor independence

appears to be conditional upon auditor type, the NAF variable is replaced with another fee

measure,FEERATIOvariable (Model (4)), to get further insights. Again following Norton et al.s

(2004)approach, now the results for the strict control sample suggest significant observations for

the interaction with the FEERATIO10

variable and primarily for those companies that have apredicted probability between 0.4 and 0.7 of receiving a GCO (see Table 5, Panel D, and Figure

3). Hence, there is no support for H1a. Indeed, contradictory to the prediction, the findings

suggest that Big 4 audit firms appear to be less likely than their non-Big 4 counterparts to issue a

GCO if the level of non-audit fees is relatively high and the client is highly financially stressed.

Further descriptive statistics show that Big 4 audit firms provide relatively more non-audit

services for their clients (FEERATIO: meanBIG4: 0.67, meanNONBIG4: 0.41, difference: 0.000***

based on both a t-test and a Wilcoxon-Mann-Whitney Test).11 The relatively high importance of

non-audit services in Big 4 audit engagements appears to provide an incentive for the Big 4

8In an additional unreported specification of Model (1), market variables such as volatility, return on total assets,and beta are included in the model. This significantly reduces the sample size due to data constraints on thesevariables. Yet, the main results are essentially unchanged in both samples. An alternative probability ofbankruptcy measure, the Altman (1968) Z-score, is also used in Model (1). Like the PROB variable, thecoefficient on the Altman Z-score variable is also positive and highly significant. The main results, which are notreported here, are essentially unchanged in both samples. Furthermore, an alternative coding for tenure is used inModel (1), as there are arguments that the relationship is non-linear. First, a dummy variable that capturesauditor switches is used. Second, a dummy variable that captures long auditor-client relationships is used, i.e., anauditor-client relationship that is longer than three years (Knechel and Vanstraelen 2007). For bothspecifications, the main results are essentially unchanged in both samples; those results are not reported here.The latter variable measurement is also used in Model (3).

9 In additional not reported specifications of Models (2) to (4), the variables are mean-centered before creating theinteraction term. The main results remain essentially unchanged. Additional specifications of Models (2) to (4)

control for zero non-audit services. Again, the main results continue to hold.10 In an additional not reported specification, the influence of theFEERATIOvariable (without interaction effect) is

estimated. However, like for the NAFand AF variables, an insignificant relationship can be found.11

*, **, *** Indicate significance levels at 0.1, 0.05, and 0.01, respectively (two-tailed tests).

144 Ratzinger-Sakel



17/41

TA

BLE4

CorrelationMatrixforGoingConcernCompaniesandControlSampleC

ompanies(n

708)

PanelA:CorrelationMatrixforVariablesGCO

toINVEST

GCO

NAF

AF

FEERAT

IO

SIZE

AGE

PROB

CFO

INVEST

GCO

1.000

NAF

0.018

1.000

AF

0.031

0.678***

1.000

FEERATIO

0.014

0.546***

0.085

1.000

SIZE

0.098***

0.656***

0.876***

0.193***

1.000

AGE

0.050

0.167***

0.191***

0.052

0.230***

1.000

PROB

0.457***

0.097***

0.127***

0.012

0.232***

0.080**

1.000

CFO

0.260***

0.136***

0.197***

0.035

0.272***

0.152**

*

0.354***

1.000

INVEST

0.009

0.152***

0.230***

0.022

0.218***

0.244**

*

0.060

0.197***

1.000

TENURE

0.017

0.334***

0.346***

0.118***

0.314***

0.135**

*

0.075**

0.060

0.058

lg_

TENUR

E

0.012

0.187***

0.164***

0.041

0.168***

0.124**

*

0.123***

0.012

0.013

BIGFOUR

0.033

0.296***

0.380***

0.175***

0.398***

0.094**

0.060

0.114***

0.056

REPORLA

G

0.222***

0.233***

0.246***

0.070*

0.306***

0.046

0.371***

0.132***

0.120***

LISTED

0.048

0.513***

0.642***

0.124***

0.653***

0.050

0.077**

0.107***

0.107***

AC

0.030

0.374***

0.476***

0.120***

0.505***

0.183**

*

0.131***

0.113***

0.121***

RISK

0.224***

0.028

0.061

0.008

0.062*

0.063*

0.213***

0.128***

0.005

OPERATING

0.100***

0.088**

0.236***

0.052

0.222***

0.102**

*

0.008

0.046

0.022

STRATEG

IC_

ST

0.012

0.080**

0.093**

0.065*

0.115***

0.020

0.036

0.051

0.039

STRATEG

IC_

LT

0.140***

0.270***

0.331***

0.092**

0.355***

0.024

0.142***

0.141***

0.069*

(continuedonnextpage)




18/41

TABLE4(continued)

PanelB:

ContinuedCorrelationMatrixforVariablesTENUREtoSTRATEGIC_

LT

TENURE

lg_

TENUR

E

BIGFOUR

REPORT-

LAG

LISTED

AC

RISK

OPER-

ATING

STRA-

TEGIC_

ST

STRA-

TEGIC_

LT

TENURE

1.000

lg_

TENUR

E

0.683***

1.000

BIGFOUR

0.087**

0.062

1.000

REPORLA

G

0.105***

0.115*

**

0.145***

1.000

LISTED

0.222***

0.080*

*

0.248***

0.245***

1.000

AC

0.175**

0.086*

*

0.308***

0.285***

0.372***

1.000

RISK

0.050

0.046

0.074**

0.142***

0.022

0.000

1

.000

OPERATING

0.174***

0.025

0.065*

0.022

0.185***

0.080**

0

.061

1.000

STRATEG

IC_

ST

0.063*

0.036

0.128***

0.108***

0.084**

0.077**

0

.010

0.220***

1.000

STRATEG

IC_

LT

0.169***

0.123*

**

0.139***

0.161***

0.301***

0.170***

0

.056

0.274***

0.249***

1.000

*,**,***

Significancelevelsat0.1,0.05,and0.01,respectively,two-tailedtests.

146 Ratzinger-Sakel



19/41

TABLE 5

Logistic Regressions

Panel A: Going Concern Companies and Entire Control Sample Companies Model (1*) and

Model (1) (n708)

Variables

Model (1*) Model (1)

Coeff. Z p-value Coeff. Z p-value

Test Variables

NAF 0.021 0.18 0.856 0.066 0.54 0.589

AF 0.275 0.82 0.412 0.175 0.49 0.627

Other Variables of Interest

RISK 0.998 2.72 0.006***

OPERATING 2.488 3.27 0.001***

STRATEGIC_ST 0.145 0.35 0.728STRATEGIC_LT 2.057 3.17 0.002***

Control Variables

SIZE 0.031 0.13 0.895 0.138 0.58 0.564

AGE 0.001 0.28 0.778 0.004 0.69 0.489PROB 3.384 7.62 0.000*** 3.324 7.06 0.000***

CFO 2.371 2.15 0.032** 2.468 2.19 0.028**INVEST 0.268 0.25 0.805 0.125 0.14 0.892TENURE/lg_TENURE 0.075 1.20 0.229 0.096 1.54 0.123

BIGFOUR 0.290 0.77 0.441 0.368 0.97 0.331REPORTLAG 0.005 1.34 0.180 0.003 0.77 0.444

LISTED 0.982 1.53 0.127 1.217 1.62 0.105AC 0.449 1.02 0.306 0.218 0.49 0.623

Constant 6.422 3.43 0.001*** 7.795 3.88 0.000***Year dummies included included

Wald Chi-square 105.78*** 113.99***

Pseudo R2 29.59 37.54

Panel B: Going Concern Companies and Entire Control Sample Companies Models (2)(4)

(n708)

Variables

Model (2) Model (3) Model (4)

Coeff. Z p-value Coeff. Z p-value Coeff. Z p-value

Test Variablesa

NAF 0.241 1.09 0.277 0.093 0.44 0.662AF 0.262 0.49 0.624 0.831 1.45 0.146NAF BIGFOUR 0.029 1.03 0.303

(0.06)AF BIGFOUR 0.030 1.20 0.228

(0.03)

NAF lg_TENURE 0.013 0.94 0.346(0.04)

AF lg_TENURE 0.053 1.32 0.188(0.03)





20/41

TABLE 5 (continued)

Variables



FEERATIO

BIGFOUR 0.065 1.59 0.112(0.03)FEERATIO 1.102 1.79 0.074*


RISK 1.055 2.96 0.003*** 0.976 2.71 0.007*** 1.066 2.82 0.005***

OPERATING 2.461 3.17 0.002*** 2.640 3.55 0.000*** 2 .685 3.43 0.001***

STRATEGIC_ST 0.130 0.31 0.758 0.154 0.37 0.713 0.145 0.34 0.730STRATEGIC_LT 2.136 3.26 0.001*** 2.122 3.39 0.001***2.096 3.25 0.001***

Control Variables

SIZE 0.164 0.68 0.498 0.121 0.49 0.622 0.250 1.57 0.115

AGE 0.004 0.79 0.427 0.004 0.81 0.416 0.004 0.73 0.468

PROB 3.322 7.12 0.000*** 3.428 7.20 0.000*** 3.328 7.25 0.000***CFO 2.408 2.18 0.029** 2.256 1.90 0.058* 2.601 2.34 0.019**INVEST 0.033 0.04 0.971 0.094 0.10 0.921 0.164 0.18 0.856

TENURE/

lg_TENURE

0.092 1.45 0.147 3.407 1.46 0.144 0.099 1.54 0.125

BIGFOUR 2.387 1.18 0.239 0.361 0.96 0.338 0.128 0.23 0.815REPORTLAG 0.003 0.80 0.421 0.004 1.06 0.287 0.004 0.94 0.349

LISTED 1.230 1.56 0.119 1.118 1.48 0.138 1.114 1.52 0.129AC 0.230 0.50 0.617 0.238 0.54 0.592 0.270 0.59 0.552

Constant 6.521 2.58 0.010***10.349 3.52 0.000***8.664 4.45 0.000***Year dummies included included included

Wald Chi-square 117.24*** 117.90*** 112.93***Pseudo R2 38.05 37.90 38.29

Panel C: Going Concern Companies and Strict Control Sample Companies Model (1*) and

Model (1) (n167)

Variables



Test Variables

NAF 0.068 0.50 0.614 0.107 0.76 0.448

AF 0.610 1.30 0.193 0.550 1.22 0.224


RISK 0.804 1.74 0.081*

OPERATING 2.258 2.20 0.028**

STRATEGIC_ST 0.274 0.47 0.639STRATEGIC_LT 1.669 2.23 0.026**

Control Variables

SIZE 0.092 0.36 0.721 0.132 0.56 0.577

AGE 0.009 1.40 0.161 0.009 1.40 0.163PROB 3.252 5.80 0.000*** 3.264 5.17 0.000***

CFO 1.747 1.18 0.236 1.739 1.40 0.161

INVEST 0.548 0.41 0.681 0.018 0.01 0.988TENURE/lg_TENURE 0.121 1.44 0.149 0.137 1.63 0.104



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TABLE 5 (continued)

Variables



LISTED 0.850 1.19 0.233 1.178 1.18 0.236AC 0.130 0.22 0.824 0.250 0.42 0.676


Wald Chi-square 45.63*** 50.97***

Pseudo R2 26.95 33.94

Panel D: Going Concern Companies and Strict Control Sample Companies Models (2)(4) (n

167)

Variables



Test Variablesa

NAF 0.448 1.85 0.064* 0.165 0.75 0.455AF 0.717 1.23 0.219 1.569 1.70 0.089*NAF BIGFOUR 0.035 1.79 0.073*

(0.04)AF BIGFOUR 0.236 3.30 0.001***

(0.05)

NAF lg_TENURE 0.037 1.47 0.141(0.06)

AF lg_TENURE 0.145 1.22 0.224(0.03)

FEERATIO BIGFOUR 0.316 2.94 0.003***(1.46)

FEERATIO 2.058 2.75 0.006***


RISK 1.208 2.43 0.015** 0.766 1.72 0.085* 0.983 2.22 0.026**

OPERATING 2.289 2.13 0.034** 2.257 2.19 0.029** 2.724 2.30 0.021**

STRATEGIC_ST 0.347 0.56 0.573 0.316 0.54 0.588 0.350 0.58 0.561STRATEGIC_LT 2.053 2.57 0.010*** 1.880 2.49 0.013** 2.044 2.43 0.015**

Control Variables

SIZE 0.261 0.90 0.369 0.097 0.39 0.693 0.468 2.18 0.029**AGE 0.013 1.55 0.122 0.010 1.38 0.169 0.010 1.26 0.207PROB 3.528 5.44 0.000*** 3.374 4.87 0.000*** 3.410 5.28 0.000***

CFO 1.867 1.22 0.221 1.921 1.38 0.167 1.310 1.08 0.278

INVEST 0.023 0.02 0.986 0.064 0.05 0.960 0.236 0.19 0.848TENURE/lg_TENURE 0.166 1.72 0.086* 4.136 1.11 0.268 0.138 1.60 0.109

BIGFOUR 7.864 3.01 0.003*** 0.076 0.14 0.889 1.314 1.71 0.087*REPORTLAG 0.004 0.73 0.463 0.003 0.51 0.613 0.004 0.70 0.481

LISTED 1.465 1.35 0.178 1.162 1.19 0.233 1.245 1.23 0.219AC 0.232 0.36 0.718 0.219 0.37 0.711 0.071 0.13 0.900

Constant 4.313 1.54 0.124 10.792 2.60 0.009***9.459 3.49 0.000***

Year dummies included included included





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auditor to keep the client, resulting in less reports on going concern issues for engagements

characterized by both relatively high levels of non-audit fees and financial stress. For audits with

a long audit firm tenure in Model (3), the results do not document a significant relationship

between the levels of the non-audit fees and the likelihood that an auditor issues a GCO. Hence,

H1b can be supported.

The coefficient on theAFvariable is also insignificant in Model (1). Consequently, there is no

support for H2 either. This result holds for both control samples.12 For the interaction effect with

the type of auditor (Model (2)) while the p-value of the coefficient on theAF BIGFOURvariable,based on the ordinary regression output, is positive and significant for the strict control sample,

Norton et al.s (2004)approach supports an insignificant finding (see Table 5, Panel D, and also

Figure 2). Hence, there is no support for H2a. In addition, for audits with a long audit firm tenure

(Model (3)) an insignificant relationship between the level of audit fees and the likelihood that an

auditor issues a GCO can be documented. Hence, H2b can be supported.

In terms of the other variables of interest, a comparison of Model (1*), which only includes

more traditional variables and no advanced risk variables (i.e., RISK, OPERATING,STRATEGIC_ST, and STRATEGIC_LT), with Model (1) provides insights. This comparison

indicates that the risk variables do add incremental power to the model, as reflected by the R2

increase. The positive, significant relationship for RISK in Model (1) adds some support to the

importance of the disclosures on liquidity risks in the German going concern reporting context as

theCFO and theINVESTvariables also capture the influence of liquidity problems. The results for

the other variables of interestOPERATING, STRATEGIC_ST, and STRATEGIC_LTsuggest that

operating initiatives are undertaken mostly by going concern companies to solve their financial

problems in the short run. However, contrary toBruynseels and Willekens (2012),the results do not

support the view that only those strategic actions with a short-term impact reduce the likelihood that

a company receives a GCO. In fact, the coefficient onSTRATEGIC_STis negative yet insignificant,while the coefficient on STRATEGIC_LT is negative and significant, suggesting that due to their

financial situation, companies that are confronting going concern problems are not able to undertake

strategic actions that have a long-term impact. The PROBvariable has the highest explanatory value

in the model (see Z-scores). Although the positive and significant relationship for PROB is

intuitively clear, it appears that in Germany, regardless of which control sample is considered,

going concern and the non-going-concern companies are significantly different in terms of their

probability of bankruptcy. This difference is supported by the univariate analysis.

TABLE 5 (continued)

Variables



Wald Chi-square 65.44*** 55.24*** 52.11***Pseudo R2 38.52 34.47 36.94

*, **, *** Significance levels at 0.1, 0.05, and 0.01, respectively, two-tailed tests.aFollowingNorton et al.s (2004)approach for the coefficient on the interaction effect Stata INTEFF results are reported;

the mean of INTEFF Z-statistic is reported in parentheses.

12 A power analysis (Stata powerreg) is conducted because of the small sample size and the finding of ainsignificant relationship. The power analysis suggests that for a power of 0.7 (0.8), a sample size of 473 (594) isneeded. The sample size of the entire control sample is 708. Hence, if the effect of a significant relationshipbetweenNAFand AF, and going concern report modifications was present, as it is in prior studies, there is a 0.7(0.8) power of detecting this effect in the entire control sample.

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ADDITIONAL TESTS

Additional tests on model specifications are conducted. First, to capture the potential influence

of unexpected fees on auditors reporting decisions, a fee model is estimated. Variables for audit

and non-audit fees are determined based on prior German research on audit and non-audit fee

determinants(Kohler et al. 2010; Kohler and Ratzinger-Sakel 2012; Kohler and Ratzinger-Sakel

2013)(for variable definitions of Models (5) and (6), see Table 6 ). Unexpected fees are captured by

the residuals of the corresponding regression models:13

AF k0k1SIZEk2COMPLk3RECV k4EBITk5LEVk6BIGFOURk7AUDCHGk8LISTEDk9SECk10ACk11FY k12REPORTLAG

k13FEe5: 5

NAF p0p1SIZEp2COMPLp3RECVp4EBIT p5LEV p6BIGFOURp7AUDCHGp8LISTEDp9SECp10ACp11LOSSp12FEe6: 6

The OLS models have high explanatory power with an adjusted R2 of 84.23 percent for the AF

model and an adjusted R2 of 49.03 percent for theNAFmodel. To analyze the impact of unexpected

FIGURE 1

Z-Statistic NAF BIGFOUR

Based onNorton et al.s (2004) approach.

13International fee studies frequently include company-specific information on one-off events, such as M&Atransactions, in non-audit fee models. However, in Germany the access to such information is limited, and annual

reports are generally not helpful, as they usually do not provide a complete picture of such events.




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fees on auditors going concern decisions, the fee variables in Models (1) to (4) are replaced with

the unexpected fees obtained from Models (5) and (6). Consistent with the findings in Model (1),

the results demonstrate an insignificant relationship between both the level of the unexpected

non-audit fees (UNEXP_NAF) and the level of unexpected audit fees (UNEXP_AF) and the

likelihood that an auditor issues a GCO. The models including interaction effects with unexpected

fees do not lend further support to the fact that Big 4 audit firms appear to be less likely to issue a

GCO for engagements characterized by both relatively high levels of non-audit fees and financial

stress (see Table 6).

Second, prior research highlights the potential endogeneity between GCO, non-audit fees, and

audit fees. Given the problematic nature of the joint estimation of a simultaneous equation system

with one or more binary dependent variables (here, GCO), a two-stage approach is used

(Wooldridge 2000). For the three potential endogenous variables GCO, NAF, and AF, three

structural models are developed. The GCO model comprises all independent variables used in

Equation (1). The AF model comprises all independent variables used in Equation (5) and also

includes GCO and NAF as endogenous variables. The NAF model comprises all independent

variables in Equation (6) and also includes GCO and AF as endogenous variables.

In the first stage, the three endogenous variables are estimated by using all exogenous

variables, in reduced-form models. In the second stage, the influence of the estimated endogenous

variables from the first stage is estimated, which are labeledHAT_GCO,HAT_AF, andHAT_NAF,

as well as of the remaining independent variables on the corresponding dependent variables. Then a

Durbin-Wu-Hausman (DWH) test for endogeneity (Durbin 1954; Wu 1973; Hausman 1978) is

FIGURE 2

Z-Statistic AF BIGFOUR

Based onNorton et al.s (2004)approach.

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performed. The results were as follows: ForNAFin theGCO model, the p-value was 0.008 for the

entire control sample and 0.000 for the strict control sample. ForAFin theGCOmodel, the p-value

was 0.100 for the entire control sample. Based on these results, the second-stage structural equation

model forGCO is re-estimated by replacing the endogenous variables NAFand AFwith the fitted

variablesHAT_NAFand HAT_AFfor both the entire and the strict control sample. In contradiction

to the Model (1) findings, the results show an unexpected significant, positive relationship between

HAT_NAFand the likelihood that an auditor issues a GCO. This result suggests that even in their

financially stressed situation, companies facing going concern problems demand non-audit servicesfrom their auditor. An opposing argument to this finding is that going concern companies cannot

afford non-audit services. However, as mentioned above, in general going concern companies do

not go bankrupt in the subsequent year in Germany. Therefore, to solve their problems in the

short-run and hence to recover, those companies may be investing the financial reserves they still

have in non-audit services. The models that include interaction effects with the estimated fees do

not support the view that the potential for non-audit services to impair auditor independence

depends on the type of audit firm conducting the audit (see Table 7).

CONCLUSION AND LIMITATIONS

This study provides new empirical evidence on the relationship between audit and non-audit

fees and auditors reporting behavior for financially stressed companies in Germany. The German

setting is characterized by unique reporting requirements and a lower litigation risk compared to

FIGURE 3

Z-Statistic FEERATIO BIGFOUR

Based onNorton et al.s (2004) approach.




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Anglo-Saxon environments. In Germany, when the level of non-audit fees is high, auditors

incentives to raise fewer going concern issues in the auditors report appear to be more pronounced

than in Anglo-Saxon settings.

Based on a sample of financially stressed manufacturing companies for the period 20052009,

there is little evidence that German auditors are less independent when the level of non-audit fees is

high in general, although there is evidence of such impairment when a Big 4 audit firm receives

TABLE 6

Logistic Regressions with Unexpected Fees

Panel A: Going Concern Companies and Entire Control Sample Companies Model (1) and

Model (2) (n708)

Variables

Model (1) Model (2)


Test Variablesa

UNEXP_NAF 0.008 0.07 0.943 0.107 0.52 0.604UNEXP_AF 0.114 0.25 0.800 0.493 0.83 0.407UNEXP_NAF BIGFOUR 0.009 0.70 0.484

(0.24)UNEXP_AF BIGFOUR 0.054 1.15 0.249

(1.00)

UNEXP_NAF lg_TENURE

UNEXP_AF lg_TENURE

UNEXP_FEERATIO BIGFOUR

UNEXP_FEERATIO


RISK 1.001 2.75 0.006*** 1.036 2.86 0.004***

OPERATING 2.479 3.22 0.001*** 2.459 3.25 0.001***

STRATEGIC_ST 0.143 0.35 0.727 0.117 0.28 0.778STRATEGIC_LT 2.030 3.13 0.002*** 2.127 3.25 0.001***

Control Variables

SIZE 0.245 1.49 0.136 0.273 1.59 0.112

AGE 0.003 0.59 0.555 0.003 0.69 0.490PROB 3.392 7.24 0.000*** 3.410 7.36 0.000***

CFO 2.588 2.30 0.022** 2.444 2.14 0.033**INVEST 0.116 0.13 0.898 0.104 0.12 0.907

TENURE/lg_TENURE 0.104 1.66 0.097* 0.099 1.58 0.115


LISTED 1.087 1.52 0.130 1.111 1.48 0.139AC 0.256 0.58 0.564 0.239 0.53 0.599


Wald Chi-square 111.39*** 113.27***

Pseudo R2 37.37 37.85


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relatively high non-audit fees from a client in extreme financial distress. This finding implies that

general concerns about accuracy, professional responsibilities, and reputation may usually guide

auditor decisions. However, those safeguards may not be adequate in all situations given the

relatively low litigation risk in Germany. It is notable that this finding is sensitive to the model

specification.

This study is subject to some caveats. First, the sample is fairly small in size. Nevertheless,

since the sample comprises all German nonfinancial companies that received a first-time GCO,

TABLE 6 (continued)

Panel B: Going Concern Companies and Entire Control Sample Companies Model (3) and

Model (4) (n708)

Variables

Model (3) Model (4)


Test variablesa

UNEXP_NAF 0.242 1.16 0.248UNEXP_AF 0.754 0.93 0.351

UNEXP_NAF BIGFOUR

UNEXP_AF BIGFOUR

UNEXP_NAF lg_TENURE 0.016 1.37 0.170(0.16)

UNEXP_AF lg_TENURE 0.035 0.80 0.180(0.18)

UNEXP_FEERATIO BIGFOUR 0.001 2.42 0.016**(0.02)

UNEXP_FEERATIO 0.016 1.86 0.063*


RISK 0.983 2.74 0.006*** 0.994 2.73 0.006***

OPERATING 2.592 3.43 0.001*** 2.513 3.29 0.001***

STRATEGIC_ST 0.122 0.29 0.771 0.069 0.17 0.864STRATEGIC_LT 2.127 3.38 0.001*** 2.145 3.35 0.001***

Control Variables

SIZE 0.251 1.61 0.108 0.269 1.68 0.093*AGE 0.003 0.69 0.492 0.003 0.57 0.571PROB 3.424 7.19 0.000*** 3.424 7.22 0.000***

CFO 2.561 2.16 0.031** 2.613 2.24 0.025**INVEST 0.024 0.03 0.980 0.086 0.09 0.928TENURE/lg_TENURE 0.600 1.34 0.180 0.098 1.54 0.125


LISTED 0.949 1.34 0.180 1.175 1.65 0.100*AC 0.345 0.77 0.439 0.289 0.65 0.519


Wald Chi-square 114.39*** 113.62***

Pseudo R2 37.75 38.11





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those companies that are relevant to my research questions are considered. Also, by considering

both an entire and a strict control sample in the analysis, the small sample size is addressed. Second,

since the null hypothesis of H1 cannot be rejected, it cannot be ruled out that non-audit services

have some potential to cause problems. Third, the weak evidence that Big 4 audit firms are less

likely to issue a GCO when the level of non-audit fees is relatively high and when the client is

highly financially stressed could indicate compromised independence. However, the opposite

argument that the provision of non-audit services actually helps the client, thereby giving them the

legitimate possibility to avoid the GCO, cannot be ruled out. Even if the tests cannot disentangle the

two possible effects, the existence of a negative relationship is also consistent with compromised

auditor independence.

TABLE 6 (continued)

Panel C: Going Concern Companies and Strict Control Sample Companies Model (1) and

Model (2) (n167)

Variable

Model (1) Model (2)

Coeff. z p-value Coeff. z p-value

Test Variablesa

UNEXP_NAF 0.018 0.12 0.903 0.379 1.33 0.185

UNEXP_AF 0.383 0.81 0.416 1.230 1.45 0.148UNEXP_NAF BIGFOUR 0.065 1.48 0.138

(0.45)UNEXP_AF BIGFOUR 0.359 2.38 0.018**

(1.43)

UNEXP_NAF lg_TENUREUNEXP_AF lg_TENURE

UNEXP_FEERATIO BIGFOURUNEXP_FEERATIO


RISK 0.859 1.88 0.061* 1.140 2.41 0.016**

OPERATING 2.321 2.24 0.025** 2.490 2.49 0.013**

STRATEGIC_ST 0.289 0.51 0.611 0.249 0.39 0.699STRATEGIC_LT 1.531 2.11 0.035** 2.158 2.81 0.005***

Control Variables

SIZE 0.386 2.10 0.036** 0.613 2.38 0.017**

AGE 0.009 1.36 0.173 0.011 1.39 0.166PROB 3.285 5.25 0.000*** 3.547 5.00 0.000***

CFO 1.409 1.23 0.219 1.781 1.37 0.171INVEST 0.059 0.05 0.961 0.414 0.32 0.747TENURE/lg_TENURE 0.157 1.93 0.054* 0.163 1.86 0.063*


LISTED 0.905 0.93 0.351 0.709 0.67 0.506AC 0.111 0.19 0.847 0.233 0.39 0.699


Wald Chi-square 49.29*** 53.41***

Pseudo R2 33.29 36.85


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TABLE 6 (continued)

Panel D: Going Concern Companies and Strict Control Sample Companies Model (3) and

Model (4) (n167)

Variable

Model (3) Model (4)

Coeff. z p-value Coeff. z p-value

Test Variablesa

UNEXP_NAF 0.316 1.19 0.235UNEXP_AF 0.967 1.11 0.267

UNEXP_NAF BIGFOURUNEXP_AF BIGFOURUNEXP_NAF lg_TENURE 0.066 1.49 0.136

(0.46)

UNEXP_AF lg_TENURE 0.072 0.58 0.562(0.33)

UNEXP_FEERATIO BIGFOUR 0.003 2.39 0.017**(0.04)

UNEXP_FEERATIO 0.016 1.89 0.059*


RISK 0.847 1.90 0.057* 0.888 1

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