Effects of SOX 404(b) Implementation on Audit Fees by SEC Filer Size Category

49 Pages Posted: 8 Feb 2017 Last revised: 12 Oct 2017

See all articles by Michael Ettredge

Michael Ettredge

University of Kansas - Accounting and Information Systems Area

Matthew Sherwood

University of Massachusetts Amherst - Isenberg School of Management

Lili Sun

University of North Texas - Department of Accounting

Date Written: October 12, 2017

Abstract

This study provides novel information about the consequences of the Sarbanes-Oxley Act (SOX) by documenting differential audit fee shocks accompanying implementation of SOX 404(b) internal control tests and reports for clients in three size categories: large accelerated filers (LAFs), small accelerated filers (SAFs), and non-accelerated filers (NAFs). First, we find that although both LAFs and SAFs experience audit fee shocks attributable to 404(b), SAFs on average experience relatively greater fee shocks than LAFs (107.8% percent versus 84.6% percent; Table 6). Second, even though NAFs are not subject to 404(b) procedures, we document a 42.7% percent fee shock for NAFs. Our interpretation is that 404(b) generated an immediate increase in demand for audit services with no corresponding sudden increase in supply of experienced audit personnel, enabling audit firms to charge higher prices for all filers including NAFs. We find that audit fee shocks attributable to 404(b) are positively associated with audit offices’ bargaining power relative to clients, and that the effect of offices’ bargaining power is strongest for SAFs and weakest for NAFs. Although higher audit fees (with client characteristics held constant) are often considered an indicator of better audit quality, we find virtually no evidence that the massive fee increases in 2004 are accompanied by improvements in same-year or next-year audit quality, measured as decreases in discretionary accruals and a lower likelihood of subsequent restatements of audited financial reports.

Keywords: SOX 404(B) Audit, Internal Controls, Audit Fees, Large Accelerated Filers, Small Accelerated Filers, Non-Accelerated Filers, Audit Office, Bargaining Power

Suggested Citation

Ettredge, Michael L. and Sherwood, Matthew and Sun, Lili, Effects of SOX 404(b) Implementation on Audit Fees by SEC Filer Size Category (October 12, 2017). Journal of Accounting and Public Policy, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2913054 or http://dx.doi.org/10.2139/ssrn.2913054

Michael L. Ettredge (Contact Author)

University of Kansas - Accounting and Information Systems Area ( email )

1300 Sunnyside Avenue
Lawrence, KS 66045
United States
785-864-7537 (Phone)
785-864-5328 (Fax)

Matthew Sherwood

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Lili Sun

University of North Texas - Department of Accounting ( email )

1155 Union Circle #305219
Denton, TX 76203-5017
United States
940-565-3077 (Phone)

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