‘Post-Sarbanes–Oxley changes in the composition of boards: Have they impacted spending for audit services?’
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The issue of the importance of the independent auditor's audit to the integrity of corporate financial statements has been a staple of the corporate governance and financial market functioning literature since the Securities Act of 1933 and the Securities Exchange Act of 1934. These acts required auditor attestation of corporate financial statements. Subsequent to the passage of the auditor attestation requirement, occasional financial reporting scandals erupted. None of these had the impact of the Enron/Worldcom scandals of 2001 and 2002. These scandals illustrated the ability of corporate management to game the corporation's financial statements, despite – or perhaps with the tacit concurrence of – the boards of directors of affected firms. Accordingly, much of the 2002 legal response to corporate financial reporting scandals came in the form of new corporate governance requirements on all publicly held firms. The impact of these requirements, however, differed between firms. Some firms had introduced use of independent directors and fully independent committees before their being made compulsory in 2002. One instrument of control over corporate management that the board of directors possesses, in actuality or potentially, is control of the extent of the work of the independent auditors. The auditors’ work can result in the board learning of accounting-related corporate mis-and malfeasance. Accordingly, the extent of the auditor's work is important and the obvious surrogate for this effort is the audit fee. This investigation examines the effect on spending by listed firms for audit services attributable to the Sarbanes–Oxley Act of 2002 and related stock exchange regulations. It uses the difference-in-differences methodology to overcome endogeneity concerns. The results reveal that firms that were compelled by law to change their boards increased their spending on financial statement-related audit services more than did firms that had pre-adopted the Sarbanes–Oxley corporate board composition requirements.