The effects of board and auditor independence on earnings quality: evidence from Italy

Most regulations and corporate governance codes emphasize the adjective independent next to the words auditor and director because auditor and director independence is expected to result in better protection for shareholders and other stakeholders. In this study we use (1) the extent to which the auditor provides non-audit services (NAS) to clients as a possible factor influencing auditor independence and (2) the proportion of outside independent directors to the total number of directors as a proxy of board of directors’ independence (BODI). The two fundamental questions are the following: (1) Does the provision of NAS by auditors to audit clients impair auditor independence, thus reducing the quality of earnings? (2) Does BODI play a role in improving earnings quality? An empirical analysis is conducted on a sample of Italian listed companies during the period 2007–2010. Our evidence does not show an influence of BODI on our proxies of earnings management. Regarding the issue of auditor independence, the provision of NAS appears to be positively associated with the absolute abnormal working capital accruals, which is an indicator of a lower quality of earnings. We also show that board characteristics are not determinants in the choice of purchasing NAS and that the new Italian regulation on mandatory disclosure of audit and NAS fees appears to have had some influence on the behavior of companies in the 2007–2010 period in the form of a reduction in the relative magnitude of NAS compared to audit fees.