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    Did SOX Influence the Association between Fee Dependence and...
    research summary posted February 20, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
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    Title:
    Did SOX Influence the Association between Fee Dependence and Auditors’ Propensity to Issue Going-Concern Opinions?
    Practical Implications:

    This research note presents evidence that the question of whether new standards or regulations have achieved the objective of altering the behavior of their intended target cannot be adequately assessed shortly after they have come into effect, as the implementation often requires a steep learning curve and is frequently accompanied by intense public debates and media scrutiny. From the policy standpoint, it suggests that the concern expressed by the U.S, Treasury Department officials about auditors’ applying an overly strict approach in their audits to counter elevated liability after SOX may not be warranted.

    For more information on this study, please contact Wenjun Zhang.

    Citation:

    Kao, J. L., Y. Li., and W. Zhang. 2014. Did SOX influence the association between fee dependence and auditors’ propensity to issue going-concern opinions? Auditing: A Journal of Practice and Theory 33 (2): 165-185

    Keywords:
    Fee dependence, going-concern opinion, auditor independence, SOX
    Purpose of the Study:

    Li (2009) shows that the association between fee dependence (FEEDEP) and auditors’ likelihood to issue qualified going-concern audit opinions (GCO) changes from insignificant in 2001 to positive in 2003. Since then, several studies have quoted Li’s (2009) findings as evidence that SOX has led auditors to behave more conservatively with respect to going-concern reporting.

    This research note extends Li’s (2009) post-SOX sample period from 2003 to 2011 and demonstrates that her findings for 2003 do not hold over a much longer post-SOX period, implying that SOX has had little effect on auditors’ behavior with respect to going-concern reporting for their large financially distressed clients. These results call into question whether the positive FEEDEP-GCO association identified by Li (2009) indeed represents new audit practice in the post-SOX era.

    This research note is motivated by Feldmann and Read (2010), who showed that the incidence of qualified going-concern opinions issued to subsequently bankrupt companies reverted back to the pre-Enron level by 2006-2007 after a brief increase in 2002-2003, suggesting that the year right after the passage of SOX was not typical. Thus, by focusing on 2003, researchers merely capture a transitory reaction by the audit profession to intense public scrutiny following SOX.

     

    Reference: Li, C. 2009. Does client importance affect auditor independence at the office level? Empirical evidence from going-concern opinions. Contemporary Accounting Research 26 (1): 201-230.

    Design/Method/ Approach:

    The authors run ten annual regressions (2001; 2003-2011) of auditors’ propensity to issue qualified going-concern opinions to financially distressed audit clients (GCO) on a fee dependence measure (FEEDEP). Comparing the association between GCO and FEEDEP before versus after the passage of SOX, the authors draw inferences about whether the more conservative going-concern reporting documented by Li (2009) indeed represents a long-term equilibrium behavior in the post-SOX audit market. 

    Findings:
    • The authors find no association between auditors’ propensity to issue qualified going-concern opinions to financially distressed audit clients and the fee dependence measure over an extended post-SOX period (i.e., 2003-2011), implying that SOX has had no observable lasting effect on auditor conservatism with respect to going-concern reporting.
    • The authors find that while auditors were equally cautious in issuing qualified going-concern opinions to clients that eventually failed, both before and after SOX, they have made more Type I misclassifications in 2003 by issuing qualified going-concern opinions to clients that remained solvent within two years of financial statement dates. 
    Category:
    Auditor Judgment, Independence & Ethics, Standard Setting
    Sub-category:
    Going Concern Decisions, Impact of Fees on Decisions by Auditors & Management, Impact of SOX