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The effect of ambiguity in an auditing standard on auditor independence: Evidence from nonaudit fees and SOX 404 opinions

Chan Li, K.K. Raman, Lili Sun and Da Wu

Journal of Contemporary Accounting and Economics, 2017, vol. 13, issue 1, 37-51

Abstract: We examine the relation between nonaudit fees and SOX 404 opinions on the effectiveness of a client’s internal control over financial reporting. We find a negative association between nonaudit fees and the auditor’s propensity to issue an adverse SOX 404 opinion during 2004–2006 (when AS2 was the applicable standard), but not in 2007 or 2008 (when AS5 was the applicable standard). Our results hold when we control for office size and time trend and examine tax and nontax nonaudit fees separately. These findings suggest that AS5 reduced ambiguity relative to AS2 and improved auditor independence. Our paper contributes to two literature streams: (1) the sparse literature on the adverse effects associated with ambiguity (lack of precision) in an auditing standard (Willekens and Simunic, 2007; Ye and Simunic, 2013), and (2) the AS5 literature by documenting that AS5 contributed to a more effective audit via greater auditor independence.

Keywords: Nonaudit fees; SOX 404 audit opinions; Auditor independence; Engagement risk; Ambiguity in AS2 (search for similar items in EconPapers)
JEL-codes: M42 M48 (search for similar items in EconPapers)
Date: 2017
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Journal of Contemporary Accounting and Economics is currently edited by Agnes C.S. Cheng, P. Clarkson, F.A. Gul, Zoltan Matolcsy, Dan Simunic and Ben Srinidhi

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