Have the Costs of Sox Section 404(b) Changed Over Time? An Evaluation of the Internal and External Costs of Sox Section 404(b) Compliance

Abstract

This paper uses regression discontinuity design (RDD) to estimate the evolution in the costs of Section 404(b) of the Sarbanes-Oxley Act (SOX) over time. Using regulatory compliance cutoffs as instruments in the “fuzzy” RDD, we estimate significant internal compliance costs (proxied for using adjusted selling, general, and administrative expenses) and external compliance cost premiums (proxied for using audit fees) associated with Section 404(b) compliance. While substantial in the initial years of compliance, we find that both the internal and external cost premiums declined significantly by 2009 and 2010. However, consistent with the PCAOB’s renewed emphasis on internal control audits beginning in 2010, we observe that the trend reversed and that both the estimated internal and external cost premiums returned to early SOX levels by 2015. Although we find some evidence that the increased internal costs resulted in more effective internal controls, we find no evidence that the internal controls over financial reporting (ICFR) audit yields more informative internal control reports. Together, our evidence suggests that Section 404(b) compliance costs have not materially and sustainably declined since inception and that these costs do not appear to be supported by more informed internal control reports.

Keywords: SOX Section 404(b), Internal Control Audits, Compliance Costs