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Sarbanes-Oxley increased audit costs even for firms not under the regulation, study finds

Monday, February 12, 2018

LAWRENCE — As a response to accounting and corporate scandals of the 1990s, the Sarbanes-Oxley Act of 2002 led to a greater demand for auditing services, even for companies that did not fall under the purview of the new rules, according to a recent study that includes a University of Kansas researcher.

"There are unintended consequences of this legislation and the regulation," said Michael Ettredge, the Crown/Sherr Professor of Business at KU. "It increased the cost of audits even for firms not subject to regulation. Their fees went up substantially."

In the study published in the Journal of Accounting and Public Policy, Ettredge and his co-authors documented differential audit fee shocks that accompanied the implementation of the law, known as SOX 404(b). They noted how audit fees increased for large and small firms subject to the regulation, as well as for even smaller firms that weren't subject to the new regulation, known as nonaccelerated filers. Ettredge's co-authors are Matthew Sherwood of the University of Massachusetts-Amherst and Lili Sun of the University of North Texas. Both are former KU accounting doctoral students.

The new law and general sentiment surrounding accounting scandals at the time generated an immediate increase in demand for audit services with the intent to improve companies' internal controls, which would give greater assurance to shareholders and others relying on published financial reports. However, there was no corresponding increase in the supply of experienced auditing personnel, the researchers found, which likely boosted audit fees across the board.

"It illustrates how wrong Congress can be. Many supporters stated before the legislation passed that they expected no increase in audit fees," Ettredge said. "Then, after it passed, we saw a huge increase in audit fees even among companies not subject to the regulation."

The researchers also found that smaller firms had larger increases compared with the larger firms. The smaller accelerated filers saw a 107.8 percent increase in audit fees when compared with 84.6 percent for the large accelerated filers.

"That was an unintended consequence, but it is something that has not attracted much attention," Ettredge said.

The researchers in their analysis of data from 2003 to 2005 were also unable to find evidence that the extra auditing fees companies paid resulted in better quality of auditing services.

One regulating body — though not in response to congressional action, Ettredge said — did pass new auditing standards in 2007 that attempted to reduce the cost of complying with these rules. This body was the Public Company Accounting Oversight Board, a private, nonprofit corporation created by the Sarbanes-Oxley Act as well.

"There has undoubtedly been some benefit along the lines of internal controls and financial reporting," Ettredge said. "It just cost a lot more than Congress thought it would. Plus, the nonaccelerated filers are paying more and possibly getting no benefit. We're not saying there's no improvement in companies' financial reporting that resulted from SOX 404(b). We're just saying that any improvement isn't correlated with the size of the audit fee increases."

Photo: Pexels.com.

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