Investor Perceptions of the Earnings Quality Consequences of Hiring an Affiliated Auditor

56 Pages Posted: 7 Jul 2008 Last revised: 21 Apr 2014

See all articles by William R. Baber

William R. Baber

Georgetown University - Department of Accounting and Business Law

Jagan Krishnan

Temple University - Department of Accounting

Yinqi Zhang

American University

Date Written: July 29, 2012

Abstract

The Sarbanes-Oxley Act of 2002 (SOX) proscribes so-called “affiliated hires” of financial executives. More specifically, SOX requires that firms wait at least one year before hiring an individual recently employed as a member of the firm’s external audit team. The intent of the regulation is to reduce the perceived loss of auditor independence due to affiliated hiring. SOX provisions also require that firms establish fully independent audit committees and disclose the identity of directors with financial expertise. Using a sample of firms that employ new financial executives during the period leading up to SOX, we find that earnings response coefficients (ERCs) computed using quarterly data decline following hires of individuals recently employed by the firm’s external auditor, but ERCs do not decline following hires of comparably qualified financial executives not recently employed by the external auditor. We also find that ERC declines following affiliated hires are statistically significant for firms with audit committee compositions inconsistent with SOX regulation, but not for firms with audit committees consistent with SOX regulation subsequently imposed. Further investigation using measures of earnings quality employed in prior studies suggests that the documented differences in ERC changes are attributable to perceived, rather than real, changes in earnings quality following affiliated hires.

Keywords: SOX Section 206, Affiliated Hire, Audit Quality, Earnings Response Coefficient

JEL Classification: K22, G12, G38, M41, M43, M49

Suggested Citation

Baber, William R. and Krishnan, Jagan and Zhang, Yinqi, Investor Perceptions of the Earnings Quality Consequences of Hiring an Affiliated Auditor (July 29, 2012). Available at SSRN: https://ssrn.com/abstract=1155291 or http://dx.doi.org/10.2139/ssrn.1155291

William R. Baber (Contact Author)

Georgetown University - Department of Accounting and Business Law ( email )

McDonough School of Business
Washington, DC 20057
United States

Jagan Krishnan

Temple University - Department of Accounting ( email )

Fox School of Business & Management
1801 Liacorous Walk
Philadelphia, PA 19122
United States
215-204-8126 (Phone)
215-204-5587 (Fax)

Yinqi Zhang

American University ( email )

4400 Massachusetts Ave NW
Washington, DC 20016
United States

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