Audit Quality and Accrual Reliability: Evidence from the Pre- and Post-Sarbanes-Oxley Periods

Abstract

This study examines three research questions. First, did accrual reliability improve in the post-SOX period? Second, do companies receiving higher-quality audits report accruals that are more reliable? Third, did the degree of SOX-related improvement in accrual reliability vary across companies with disparate audit quality? We first demonstrate that accrual reliability increased significantly in the post-SOX period. We next define three metrics for audit quality: audit firm industry specialization, audit-firm independence, and client-specific audit-firm litigation/reputation risk. We find evidence that accrual reliability is positively associated with each of our audit quality metrics. Finally, we find evidence that in the post-SOX period, subsamples of companies experienced more improvement in accrual reliability than others. Specifically, companies audited by non-specialist auditors, those audited by lower-independence auditors, and those that represent higher litigation/reputation risk to their auditor experienced the greatest improvement in accrual reliability in the post-SOX period.

Keywords: Sarbanes-Oxley, Audit quality, accruals, reliability

JEL Classification: K22, G38, M41, M43, M49