How Increased Regulatory Oversight of Nonaudit Services Affects Investors' Perceptions of Earnings Quality

In 2003, the Financial Supervisory Authority of Norway (FSA) disclosed that audit firms had violated the legal restrictions for providing nonaudit services (NAS). In response, the FSA tightened the NAS regulations. This study examines how regulatory oversight affects the relation between the provision of NAS and earnings response coefficients (ERC). For small, non-industry specialized audit firms, the disclosure of violations in 2003 negatively affected the relationship between NAS and ERC, but the effect was more pronounced in the disclosure year 2003 than in the new regulation period 2004-2008. For Big 5 audit firms, these negative effects are moderated, indicating higher audit quality. Contrary to our expectations, the results of this study suggest that investors perceive audit firm industry specialization as a threat to independence in 2003.