Audit Fees and Auditor Dismissals in the Sarbanes-Oxley Era

2007 ◽  
Vol 21 (4) ◽  
pp. 371-386 ◽  
Author(s):  
Michael L. Ettredge ◽  
Susan Scholz ◽  
Chan Li
Keyword(s):  
Audit Fees ◽  
Internal Controls ◽  
Public Companies ◽  
Early Evidence ◽  
Sarbanes Oxley ◽  
Big 4 ◽  
Accounting Scandals ◽  
Material Weaknesses ◽  
Going Concern Reports ◽  
The Relationship

The accounting scandals and Sarbanes-Oxley Act (SOX) of 2002 resulted in large increases in required audit work, and corresponding increases in audit fees for public companies. This study provides early evidence regarding the relationship between higher audit fees, both levels and changes, and auditor dismissals in the period immediately subsequent to the passage of SOX. We find that clients paying higher fees are more likely to dismiss their auditors. We also find that dismissals are associated with smaller companies, companies with going-concern reports, and companies that later reported material weaknesses in their internal controls. Among dismissing clients, smaller Big 4 clients, paying higher fees, tend to hire non-Big 4 successor auditors. This result holds when auditors are divided into Big 4, national, and local tiers. We also find evidence that dismissing clients, in particular clients hiring new non-Big 4 auditors, experience smaller fee increases than nonswitching clients in the following year. These results are consistent with the notion that in the immediate post-SOX period, some companies dismissed their auditors in expectation of lower fees from the succeeding auditor.

scholarly journals Auditor Compensation Pattern Of S&P 500 Corporations Before And After The Passage Of Sarbanes-Oxley Act

2011 ◽  
Vol 23 (2) ◽  
Author(s):  
Ganesh M. Pandit ◽  
Vijaya Subrahmanyam ◽  
Allen Rubenfield
Keyword(s):  
Audit Fees ◽  
Audit Process ◽  
Public Companies ◽  
Publicly Traded Companies ◽  
Corporate Scandals ◽  
Cpa Firms ◽  
Sarbanes Oxley ◽  
Big 4 ◽  
Before And After ◽  
Different Sources

<p class="MsoBodyTextIndent" style="text-align: justify; text-indent: 0in; margin: 0in 34.2pt 0pt 0.5in;"><span style="font-family: Times New Roman; font-size: x-small;">The years 2001-02 were marked with an outburst of huge corporate financial failures that eroded billions of dollars from the stockholders&rsquo; equity and shook the confidence of the investor community. One of the issues that rose to the surface was the payment of huge nonaudit service fees by publicly traded companies to their auditors.<span style="mso-spacerun: yes;">&nbsp; </span>In response to the outcry against the alleged role of the auditors in the corporate scandals, Congress passed Sarbanes-Oxley Act of 2002 (SOX), which imposed a prohibition on the supply of certain nonaudit services by a CPA firm to its audit clients in order to reduce the suspected<span style="mso-spacerun: yes;">&nbsp; </span>revenue-dependence of auditors on their audit clients.<span style="mso-spacerun: yes;">&nbsp; </span>The study described in this paper examines the pattern of auditor compensation in the years 2001 and 2004 (i.e., pre- and post-SOX periods), for a sample of large public companies, to determine how the auditor compensation has changed during this three-year period and whether the new regulations have decreased such revenue-dependence of the auditor. The study also examines if each of the Big 4 CPA firms that dominate the audit market for large public companies have experienced a change in the pattern of their revenues drawn from different sources of auditor compensation. The results show that not only the composition of auditor compensation has changed after the passage of SOX but also the overall compensation paid by the sampled companies to their auditors has gone up noticeably in many cases, primarily due to a phenomenal rise in audit fees, which still may continue to threaten the auditor&rsquo;s independence in the audit process.<span style="mso-spacerun: yes;">&nbsp; </span>Further, during this three-year period, each of the Big 4 CPA firms has shifted its emphasis on the different sources of its revenues from these large public companies.</span></p>

CEO and CFO Equity Incentives and the Pricing of Audit Services

2013 ◽  
Vol 33 (2) ◽  
pp. 1-25 ◽  
Author(s):  
B. Anthony Billings ◽  
Xinghua Gao ◽  
Yonghong Jia
Keyword(s):  
Positive Association ◽  
Audit Fees ◽  
Internal Controls ◽  
Audit Risk ◽  
Pricing Decisions ◽  
Equity Incentives ◽  
Accounting Scandals ◽  
Using Data ◽  
Distinctive Role

SUMMARY: The alleged perverse role of managerial incentives in accounting scandals, and the distinctive role of auditors in identifying and intervening in attempted earnings manipulation, highlight the importance of explicitly considering executive incentive plans by auditors in the auditing process. By empirically testing auditors' responses to CEO/CFO equity incentives in planning and pricing decisions using data from 2002 through 2009, we document compelling evidence that CFO equity incentives are positively associated with audit fees and CEO equity incentives are not statistically related to audit fees, suggesting that auditors perceive heightened audit risk associated with CFO equity incentives. Our further analyses reveal that the positive association between CFO equity incentives and audit fees is more pronounced in firms with weak internal controls, indicating heightened risk associated with CFO equity incentives in this setting perceived by auditors. JEL Classifications: G30, G34, M42, M52.

The Impact of Client and Misstatement Characteristics on the Disposition of Proposed Audit Adjustments

2011 ◽  
Vol 30 (2) ◽  
pp. 103-124 ◽  
Author(s):  
Jennifer Joe ◽  
Arnold Wright, and ◽  
Sally Wright
Keyword(s):  
Financial Reporting ◽  
Internal Controls ◽  
Data Availability ◽  
Audit Firm ◽  
Sarbanes Oxley ◽  
Big 4 ◽  
Time Period ◽  
Confidentiality Agreement ◽  
Financial Scandals ◽  
The Impact

SUMMARY We present evidence on the resolution of proposed audit adjustments during a unique time period, immediately following several U.S. financial scandals and surrounding calls for reforms in auditing and financial reporting, which culminated in the passage of the Sarbanes-Oxley Act (SOX). During this period, auditors and their clients faced increased scrutiny from investors and regulators. In addition, auditors had to contend with changed incentives, a new external regulator (i.e., the PCAOB), and upcoming annual PCAOB inspections. We extend prior studies by considering a broader range of factors potentially impacting the resolution of proposed adjustments, including the effect of client tenure, strength of internal controls, and repeat adjustments. Data on 458 proposed adjustments are obtained from the working papers of a sample of 163 audit engagements conducted during 2002 by a Big 4 firm. We find that 24.2 percent of proposed adjustments were subsequently waived. The results indicate audit adjustments are more likely to be waived for clients with whom the audit firm has had a longer relationship, although the pattern does not reflect favoring such clients. We also find that adjustments are more likely to be waived for repeat adjustments. Data Availability: Due to a confidentiality agreement with the participating audit firm the data are proprietary.

Audit Partner Tenure and Audit Planning and Pricing

2010 ◽  
Vol 29 (2) ◽  
pp. 45-70 ◽  
Author(s):  
Jean C. Bedard ◽  
Karla M. Johnstone
Keyword(s):  
Financial Reporting ◽  
Audit Quality ◽  
Internal Controls ◽  
First Year ◽  
Public Companies ◽  
Audit Opinion ◽  
Audit Firm ◽  
Audit Planning ◽  
Sarbanes Oxley ◽  
Client Knowledge

SUMMARY: This paper investigates the association between audit engagement partner tenure and audit planning and pricing. Prior archival research from countries requiring partner signature on the audit opinion provides mixed results on the implications of partner tenure for audit quality. While variation in audit quality based on partner tenure implies some difference in the conduct of the engagement, prior research has not yet addressed whether engagement processes differ based on partner tenure. Using proprietary data from a large audit firm, we find that planned engagement effort increases following partner rotation, suggesting that new partners invest effort to gain client knowledge in the first year on the engagement. We also examine planned realization rates, finding them to be lower following partner rotation. This implies that new partners’ investments in client knowledge are not compensated by clients. We also find higher planned realization rates on audits having the same engagement partner for more than five years, a longer tenure than is now allowed for public companies following the Sarbanes-Oxley Act. We obtain these results while controlling for client risks that affect audit planning and pricing, including those related to financial reporting, management integrity, and internal controls.

SOX Section 404 Material Weakness Disclosures and Audit Fees

2006 ◽  
Vol 25 (1) ◽  
pp. 99-114 ◽  
Author(s):  
K. Raghunandan ◽  
Dasaratha V. Rama
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Fees ◽  
Internal Controls ◽  
Fiscal Year ◽  
Section 404 ◽  
Control Material ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
The Mean

Section 404 of the Sarbanes-Oxley Act and Auditing Standard No. 2 (PCAOB 2004) require management and the auditor to report on internal controls over financial reporting. Section 404 is arguably the most controversial element of SOX, and much of the debate around the costs of implementing section 404 has focused on auditors' fees (Ernst & Young 2005). In this paper, we examine the association between audit fees and internal control disclosures made pursuant to section 404. Our sample includes 660 manufacturing firms that have a December 31, 2004 fiscal year-end and filed the section 404 report by May 15, 2005. We find that the mean (median) audit fees for the firms in our sample for fiscal 2004 is 86 (128) percent higher than the corresponding fees for fiscal 2003. Audit fees for fiscal 2004 are 43 percent higher for clients with a material weakness disclosure compared to clients without such disclosure; however, audit fees for fiscal 2003 are not associated with an internal control material weakness disclosure (in the 10-K filed following fiscal 2004). We also find that the association between audit fees and the presence of a material weakness disclosure does not vary depending on the type of material weakness (systemic or non-systemic).

Costs of Mandatory Periodic Audit Partner Rotation: Evidence from Audit Fees and Audit Timeliness

2016 ◽  
Vol 36 (1) ◽  
pp. 129-149 ◽  
Author(s):  
Divesh S. Sharma ◽  
Paul N. Tanyi ◽  
Barri A. Litt
Keyword(s):  
Audit Quality ◽  
Audit Fees ◽  
Data Availability ◽  
Production Costs ◽  
Specific Knowledge ◽  
Public Companies ◽  
Big 4 ◽  
Mandatory Rotation ◽  
Audit Production ◽  
Audit Partner Rotation

SUMMARY The constricted mandatory audit partner rotation rules for U.S. public companies have fueled intense debate among the profession, regulators, and policymakers. This topic remains controversial, but neither side has provided evidence of the consequential benefits and costs of mandatory rotation. While rotation effects on audit quality have been examined, we empirically examine its effects on two audit production costs: audit fees and audit timeliness. We find significantly higher audit fees and significantly longer audit report lags in the period immediately following mandatory audit partner rotation. These effects are more pronounced for non-Big 4 auditors, larger clients, and audit offices that are not industry specialists. Moreover, the audit fee and audit timeliness effects persist in successive audit partner rotations, suggesting that client-specific knowledge gained through longer audit firm engagement does not completely mitigate loss of client-specific knowledge at the partner level. Our findings provide new empirical evidence supporting the profession's arguments that mandatory audit partner rotation is costly to multiple stakeholders, including clients, auditors, and investors. Data Availability: All data are publicly available from sources identified in the text.

Earnings Management of Firms Reporting Material Internal Control Weaknesses under Section 404 of the Sarbanes-Oxley Act

2008 ◽  
Vol 27 (2) ◽  
pp. 161-179 ◽  
Author(s):  
Kam C. Chan ◽  
Barbara Farrell ◽  
Picheng Lee
Keyword(s):  
Earnings Management ◽  
Internal Control ◽  
Internal Controls ◽  
Corporate Disclosure ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Potential Benefits ◽  
Internal Control Weaknesses ◽  
Reported Earnings

SUMMARY: The main objectives of the Sarbanes-Oxley Act of 2002 are to improve the accuracy and reliability of corporate disclosure. Under Section 404 of the Sarbanes-Oxley Act, the external auditor has to report an assessment of the firm’s internal controls and attest to management’s assessment of the firm’s internal controls. Material weaknesses in internal controls must be disclosed in the auditor and management reports. The objective of this study is to examine if firms reporting material internal control weaknesses under Section 404 have more earnings management compared to other firms. The results provide mild evidence that there are more positive and absolute discretionary accruals for firms reporting material internal control weaknesses than for other firms. Since the findings of ineffective internal controls by auditors under Section 404 may cause firms to improve their internal controls, Section 404 has the potential benefits of reducing the opportunity of intentional and unintentional accounting errors and of improving the quality of reported earnings.

Material Weakness in Internal Controls and Stock Price Crash Risk

2017 ◽  
Vol 35 (1) ◽  
pp. 106-138 ◽  
Author(s):  
Gerald Lobo ◽  
Chong Wang ◽  
Xiaoou Yu ◽  
Yuping Zhao
Keyword(s):  
Financial Reporting ◽  
Stock Price ◽  
Positive Association ◽  
Internal Controls ◽  
Crash Risk ◽  
Significant Relation ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Section 302

We investigate the association between material weakness in internal controls (MW) disclosed under Section 302 of the Sarbanes–Oxley Act of 2002 (SOX) and future stock price crash risk. We argue that relative to firms with effective internal controls, firms with MW have lower financial reporting precision. The lower reporting precision (a) increases divergence of investor opinion with regard to firm valuation and (b) facilitates managers’ withholding of negative information, which increases the information asymmetry between managers and outside investors. We hypothesize that both these effects increase the probability of a future stock price crash. We find empirical evidence consistent with our prediction. In additional analyses, we document that the positive association between MW and crash risk is primarily driven by company level rather than by account-specific weaknesses, increases with the number of material weaknesses, and intensifies during the financial crisis. In addition, we find that both the existence and the disclosure of MW incrementally affect crash risk, and that MW facilitates managers’ withholding of bad news. Finally, we fail to find consistent evidence of a significant relation between MW disclosed under Section 404 of SOX and crash risk.

SOX 404 Reported Internal Control Weaknesses: A Test of COSO Framework Components and Information Technology

2009 ◽  
Vol 23 (2) ◽  
pp. 1-23 ◽  
Author(s):  
Bonnie K. Klamm ◽  
Marcia Weidenmier Watson
Keyword(s):  
Information Technology ◽  
Internal Control ◽  
Negative Impact ◽  
Internal Controls ◽  
First Year ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Assessment And Monitoring ◽  
Internal Control Weaknesses

ABSTRACT: This paper examines internal controls, from both an information technology (IT) and non-IT perspective, in relation to the five components of the Committee of Sponsoring Organization's Internal Control-Integrated Framework (COSO 1992), as well as the achievement of one of COSO's three objectives-reporting reliability. Our sample consists of 490 firms with material weaknesses reported under Sarbanes-Oxley Section 404 during the first year of compliance. We classify the weaknesses by COSO component and as IT-related or non-IT-related. Our results support the interrelationships of the COSO Framework. The results also show that the number of misstated accounts is positively related to the number of weak COSO components (i.e., scope) and certain weak COSO components (i.e., existence). Firms with IT-related weak components report more material weaknesses and misstatements than firms without IT-related weak components, providing evidence on the pervasive negative impact of weak IT controls, especially in control environment, risk assessment, and monitoring.

scholarly journals Examining the Potential Benefits of Internal Control Monitoring Technology

2010 ◽  
Vol 85 (3) ◽  
pp. 1001-1034 ◽  
Author(s):  
Adi Masli ◽  
Gary F. Peters ◽  
Vernon J. Richardson ◽  
Juan Manuel Sanchez
Keyword(s):  
Internal Control ◽  
Continuous Monitoring ◽  
Audit Fees ◽  
Monitoring Technology ◽  
Technology Governance ◽  
Sarbanes Oxley ◽  
Information Technology Governance ◽  
Time Period ◽  
Material Weaknesses ◽  
Potential Benefits

ABSTRACT: We analyze the potential benefits that firms can realize from implementing technology specifically aimed at monitoring the effectiveness of their internal control systems. The Committee of Sponsoring Organizations of the Treadway Commission asserts that effective internal control monitoring should enhance the efficiency of internal control processes, and, in turn, the assurance over such processes (COSO 2009a). We develop hypotheses to test the realization of these potential benefits. Specifically, we identify a sample of firms that implemented internal control monitoring technology in response to the internal control requirements of the Sarbanes-Oxley Act. Consistent with our hypotheses, we document that the implementation of internal control monitoring technology is associated with lower likelihood of material weaknesses, smaller increases in audit fees, and smaller increases in audit delays during the post-SOX time period. We discuss the potential implications of our findings for research related to continuous monitoring, client-provided assurance assistance, and information technology governance.

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