Investor perceptions of the earnings quality consequences of hiring an affiliated auditor

William R. Baber (), Jagan Krishnan () and Yinqi Zhang ()
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William R. Baber: Georgetown University
Jagan Krishnan: Temple University
Yinqi Zhang: American University

Review of Accounting Studies, 2014, vol. 19, issue 1, No 3, 69-102

Abstract: Abstract The Sarbanes–Oxley Act (SOX) requires that firms wait 1 year before hiring an individual employed as a member of the external audit team. SOX’s intent is to reduce the perceived loss of auditor independence due to affiliated hiring. SOX also requires fully independent audit committees and disclosure of directors with financial expertise. Using a sample of financial executive hires during the pre-SOX period, we find that earnings response coefficients (ERCs) decline following hires of individuals recently employed by the firm’s external auditor, but ERCs do not decline following hires not recently employed by the external auditor. We also find smaller ERC declines following affiliated hires for firms with audit committee compositions consistent with subsequently imposed SOX requirements. Further investigation using measures of earnings quality suggests that differences in ERC changes are attributable to perceived, rather than real, changes in earnings quality following affiliated hires.

Keywords: SOX section 206; Affiliated hire; Audit quality; Earnings response coefficient (search for similar items in EconPapers)
JEL-codes: G12 G38 K22 M41 M49 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1007/s11142-013-9244-9

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