Does Board Independence Substitute for External Audit Quality? Evidence from an Exogenous Regulatory Shock
27 Pages Posted: 28 Apr 2017
Date Written: April 28, 2017
Exploiting the passage of the Sarbanes-Oxley Act (SOX) as an exogenous regulatory shock, we investigate whether board independence substitutes for external audit quality. Based on over 14,000 observation across 18 years, our difference-in-difference estimates show that firms forced to raise board independence are far less likely to employ a Big4 auditor. In particular, board independence lowers the propensity to use a Big4 auditor by about 38%. Firms with stronger board independence enjoy more effective governance and therefore do not need as much external audit quality as those with less effective governance do. Based on a natural experiment, our empirical strategy is far less vulnerable to endogeneity and is thus much more likely to show a causal effect, rather than merely an association.
Keywords: auditor, independent directors, board independence, corporate governance, Sarbanes-Oxley, exogenous shock, natural experiment
JEL Classification: M41, M42, G34
Suggested Citation: Suggested Citation