The Effect of Ambiguity in an Auditing Standard on Auditor Independence: Evidence from Nonaudit Fees and SOX 404 Opinions
Journal of Contemporary Accounting and Economics (April 2017), 13(1): 37-51.
Posted: 3 Mar 2017 Last revised: 6 Apr 2017
Date Written: 2017
We examine the relation between nonaudit fees and SOX 404 opinions on the effectiveness of a client’s internal control over financial reporting. We find a negative association between nonaudit fees and the auditor’s propensity to issue an adverse SOX 404 opinion during 2004-2006 (when AS2 was the applicable standard), but not in 2007 or 2008 (when AS5 was the applicable standard). Our results hold when we control for office size and time trend and examine tax and nontax nonaudit fees separately. These findings suggest that AS5 reduced ambiguity relative to AS2 and improved auditor independence. Our paper contributes to two literature streams: (1) the sparse literature on the adverse effects associated with ambiguity (lack of precision) in an auditing standard (Willekens and Simunic 2007; Ye and Simunic 2013), and (2) the AS5 literature by documenting that AS5 contributed to a more effective audit via greater auditor independence.
Keywords: Nonaudit fees; SOX 404 audit opinions; Auditor independence; Engagement risk; Ambiguity in AS2.
JEL Classification: M42, M48, L13, L51
Suggested Citation: Suggested Citation