SUMMARY
The Sarbanes-Oxley Act of 2002 (SOX) effectively bars an auditor from providing nonaudit services to an audit client based on the belief that the resulting economic bonding undermines the ...auditor's independence and quality of the audit (U.S. House of Representatives 2002). The accounting profession has strongly debated this view and counter-argues that auditor-provided nonaudit services benefit the client. We contribute to this debate by examining the effect of auditor-provided nonaudit services on the effectiveness and efficiency of the audit. We find that higher nonaudit service fees are associated with shorter audit report lags—a potential indicator of audit efficiency—prior to the passage of SOX, but such effects dissipate after SOX. We find that discretionary accruals and financial restatements—potential indicators of audit effectiveness—do not increase when shorter audit lags occur in conjunction with high nonaudit service fees. We also find that the firms with the highest levels of nonaudit service fees prior to SOX have the largest increase in audit lags after SOX. These results suggest that there is some merit to the profession's argument that auditor-provided nonaudit services benefit clients without leading to a loss of audit effectiveness.
Data Availability: All data are publicly available from sources identified in the text.
SUMMARY The constricted mandatory audit partner rotation rules for U.S. public companies have fueled intense debate among the profession, regulators, and policymakers. This topic remains ...controversial, but neither side has provided evidence of the consequential benefits and costs of mandatory rotation. While rotation effects on audit quality have been examined, we empirically examine its effects on two audit production costs: audit fees and audit timeliness. We find significantly higher audit fees and significantly longer audit report lags in the period immediately following mandatory audit partner rotation. These effects are more pronounced for non-Big 4 auditors, larger clients, and audit offices that are not industry specialists. Moreover, the audit fee and audit timeliness effects persist in successive audit partner rotations, suggesting that client-specific knowledge gained through longer audit firm engagement does not completely mitigate loss of client-specific knowledge at the partner level. Our findings provide new empirical evidence supporting the profession's arguments that mandatory audit partner rotation is costly to multiple stakeholders, including clients, auditors, and investors. Data Availability: All data are publicly available from sources identified in the text.
This study examines the association between internal control deficiencies (ICDs) reported under Section 404 of the Sarbanes-Oxley Act (SOX, U.S. House of Representatives 2002) and the presence of ...former audit partners on the audit committee who are affiliated (AFAPs) and unaffiliated (UFAPs) with the firm's external auditor. We find a negative association between AFAPs and UFAPs on the audit committee and ICDs. We also find results that suggest the NYSE and NASDAQ three-year "cooling-off" rule applying to AFAPs may be unwarranted and deserves further empirical and regulatory attention. Further tests suggest AFAPs do not allow management to circumvent the disclosure of ICDs when conditions appear to suggest this may be so, and that AFAPs are negatively related to performance-adjusted discretionary accruals. Collectively, we interpret these findings to suggest that AFAPs and UFAPs on the audit committee are associated with more effective monitoring of internal controls and financial reporting.
SYNOPSIS We examine (1) the association between global-level and joint global-, national-, and city-level auditor industry specialization and audit clients’ cost of equity capital and (2) how the ...national investor protection environment impacts the preceding association. Our results indicate that cost of equity capital is negatively associated with global-level and joint global-, national-, and city-level auditor industry specialization. This relation is incrementally more negative when the auditor is a joint global-, national-, and city-level industry specialist than when the auditor is not a global-level industry specialist. We also find the negative relation between cost of equity capital and joint global-, national-, and city-level auditor industry specialization holds only in countries with strong investor protection. We further show investors perceive potential accentuation of accruals quality and ownership concentration on cost of equity is mitigated by joint global-, national-, and city-level specialist auditors. JEL Classifications: M42; G32; K49.
SUMMARY
We provide new evidence in examining whether external auditors price environmental responsibility initiatives when performing the audit of financial statements. We also examine how investors ...value the firm when environmental initiatives occur in conjunction with higher audit fees. Results show environmental initiatives are positively associated with audit fees, but the extent of this association varies across the five different types of environmental initiatives we consider. We further find that auditors appear to price environmental initiatives due to their risk rather than additional audit effort. While environmental initiatives may be costly from an audit standpoint, investors value (Tobin's Q) firms more highly when environmental initiatives occur in conjunction with higher audit fees. Collectively, our findings imply that auditors price environmental initiatives into the audit and investors value firms more highly when auditors consider this social responsibility.
SUMMARY
We find a significant negative association between cost of equity and audit committee directors' simultaneous service on multiple audit committees (ACNUM). However, this association is not ...linear, as we find that cost of equity begins to increase when ACNUM is 1.50 for non-retired directors compared to 3.50 for retired directors. Further analyses reveal the negative association is more pronounced when a firm's information environment is strong and widely used firm-level measures of multiple directorships are not related to cost of equity. The evidence we present is consistent with the notion that investors positively perceive audit committee directors' service on multiple audit committees, but only to the extent such service does not undermine directors' ability to effectively discharge their governance responsibilities. Our study informs policymakers, boards, and nominating committees and advances the literature on multiple directorships, audit committees, and cost of equity.
JEL Classifications: G12; G14; M40; M41.
Data Availability: All data are publicly available from sources identified in the text.
To address potential threats to auditor independence, the Sarbanes-Oxley Act of 2002 (SOX) requires the audit committee to pre-approve nonaudit services (NAS) procured from the auditor. However, the ...presence of a former audit firm partner (FAP) affiliated with the current auditor on the audit committee could undermine the audit committee's due diligence over the NAS pre-approval process. To alleviate such concerns, the Securities and Exchange Commission approved a three-year "cooling-off" period for appointing audit firm alumni as independent directors. Our analyses show that the presence of both affiliated and unaffiliated FAPs on audit committees does not lead to greater NAS procured from the auditor; rather, FAPs reduce NAS procured from the auditor. Moreover, NAS decline significantly following the appointment of FAPs to the audit committee. Further tests suggest the three-year cooling-off period may not be warranted and deserves further investigation. Our study raises important implications for regulators, policy makers, corporate boards, and future research.
SUMMARY Although the Sarbanes-Oxley Act of 2002 (SOX) banned most nonaudit services (NAS), it did not restrict auditors from providing tax NAS to their audit clients. In the post-SOX period, ...regulators and investors are highly concerned about the increase in tax NAS and consequently calling for restrictions. The profession contends that tax NAS are beneficial to the audit and opposes limitations. We contribute to this ongoing debate and fill a void in the literature by examining investors' perception of auditor-provided tax NAS, as reflected in the implied cost of equity capital. Our results suggest that investors require higher cost of equity capital for clients that generate more tax NAS revenue for their auditor's office. Further tests reveal that our main finding is driven by audit clients that report more uncertain tax reserves (higher tax risk), rather than clients that exhibit poor financial reporting quality. The effects we document are economically significant and robust to a large battery of sensitivity tests. Our findings suggest that investors seem to negatively perceive tax NAS because of punitive and cash flow risks associated with tax NAS. Data Availability: All data are publicly available from sources identified in the text.
