Abstract:
Firm strategy provides a holistic view of an organisation as it underpins its decisionmaking process in its pursuit to sustain and achieve growth. Empirical studies have shown a significant link between firm strategy and firm performance. This study extends the myriad of studies on firm strategy by examining the association between firm strategy and their demand for non-audit services (NAS) from auditors. This is motivated by the fact that firms continue to demand NAS despite widespread empirical evidence on the negative effects of its consumptions and the restrictions imposed by the Sarbanes-Oxley Act (SOX) 2002. It is important to understand the economic determinants of NAS, so as to better understand the implications of such restrictions. This study is undertaken using the Miles and Snow (1978) strategy typology focusing on prospectors and defenders since they reside on the extreme end of the strategy continuum. It predicts prospector demand for a higher level of NAS compared with defenders. As opposed to defenders, prospectors engage in significant amounts of research and development activities in their pursuits of new markets and opportunities. They are more likely to set up cross-border operations and experience frequent changes in their product-market domains. They engage in acquisition activities and strive to generate technological innovations to remain competitive. As they operate in a changing environment, they have greater exposure to different type of risks and experience higher employee turnover. Therefore, they may demand more NAS as compared to defenders. Following Ittner, Larcker, and Rajan (1997), I form a firm strategy composite measure from six different firm characteristics to capture the distinctive features of prospectors and defenders. My findings indicate that prospectors are associated with greater demand for NAS. Further tests suggest that they take into consideration their asset holdings and independence issues in relation to their demand for NAS. I find that my results are driven by firms audited by Deloitte or PricewaterhouseCoopers and non-audit fees incurred in relation to the audit of financial statements. I also find that industry specialists are not associated with greater purchase of NAS by their clients. Further, my findings indicate that prospectors who purchase more NAS have better operating performance in subsequent years. However, the purchase of NAS does not appear to affect investors in determining firms’ stock prices. I also find that prospectors who purchase more NAS relative to their asset holdings and total audit fees incurred are associated with higher firm valuation as proxied by Tobin’s q.