Law created after Enron scandal has costly business impact, says UNT researcher

Lili Sun, an associate professor of accounting at UNT.
Tuesday, November 7, 2017 - 16:07

DENTON (UNT), Texas — New research from the University of North Texas shows that the Sarbanes-Oxley Act – an act passed in the wake of the Enron and similar corporate scandals – has expensive consequences for corporate financial reporting and many businesses operating in the U.S.

Lili Sun, an associate professor of accounting at UNT, co-authored a paper detailing the effects of the act on audit fees and found that companies are paying more than ever for external audits – more than double in some instances – without actually receiving better quality audits.

“Companies weren’t budgeting for these fees,” said Sun, who co-authored the paper with Michael Ettredge of the University of Kansas and Matthew Sherwood of the University of Massachusetts Amherst. It will be published in the Journal of Accounting and Public Policy.

“It takes resources away from daily operations and, in the long run, strategic plans for other business-related expenses,” she said. Download a photo of Sun online.

 

Background

In the early 2000s, collapses by companies like WorldCom cost investors and shareholders billions and shook public confidence, and in 2002, Congress responded by passing the Sarbanes-Oxley Act. It mandated reforms to financial disclosures with the intent of protecting investors from corporate fraud.

 

What’s happened since?

Among the provisions, section 404(a) required managers of public companies to assess their company’s internal controls for financial reporting effectiveness. Section 404(b) required external auditors to test the internal controls and provide an opinion on the manager’s 404(a) assessments. Congress anticipated no substantial fee increases.

 

Findings

For their study, the authors examined the act’s most controversial provision – section 404(b) – according to the size of the company’s public float, or the value of shares the company has in the hands of public investors.

Analyzing audit fees before and after the act, the authors found that:

  • Large accelerated filers (companies with a public float over $700 million) had average fee increases of 84.6 percent.
  • Small accelerated filers (public floats from $75 million to $700 million) had average increases of 107.8 percent.
  • Non-accelerated filers (public floats below $75 million) were never subject to 404(b) but saw increases of 42.7 percent.

The enormous increase in audit fees is attributed to the newly-added extensive audit work and hours required by the act to evaluate companies' internal control, as well as increased audit pricing per hour of audit work. Related to the latter, the authors suggest that section 404(b) created an immediate increase in demand for audits with no corresponding increase in experienced auditors.

This allowed audit firms to charge higher prices for all filers. Although higher audit fees often indicate better audit quality, there is virtually no evidence that the massive fee increases upon the implementation of 404 audits were accompanied by improvements in same-year or next-year audit quality. These increases came despite prior assurances from regulators – creating costly implications to businesses.  

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