Audit Fees and Auditor Dismissals in the Sarbanes-Oxley Era

Abstract

The accounting scandals and Sarbanes-Oxley Act (SOX) of 2002 resulted in large increases in required audit work, and corresponding increases in audit fees for public companies. This study provides early evidence regarding the relationship between higher audit fees, both levels and changes, and auditor dismissals in the period immediately subsequent to the passage of SOX. We find that clients paying higher fees are more likely to dismiss their auditors. We also find that dismissals are associated with smaller companies, companies with going-concern reports, and companies that later reported material weaknesses in their internal controls. Among dismissing clients, smaller Big 4 clients, paying higher fees, tend to hire non-Big 4 successor auditors. This result holds when auditors are divided into Big 4, national, and local tiers. We also find evidence that dismissing clients, in particular clients hiring new non-Big 4 auditors, experience smaller fee increases than nonswitching clients in the following year. These results are consistent with the notion that in the immediate post-SOX period, some companies dismissed their auditors in expectation of lower fees from the succeeding auditor.