Management Influence on Auditor Selection and Subsequent Impairments of Auditor Independence during the Post‐SOX Period

Abstract

The objective of this study is to examine managerial involvement in auditor selection decisions when audit committees are “directly responsible” for auditor relationships, including selection of the audit firm. The Sarbanes-Oxley Act (SOX) of (2002) requires fully independent audit committees to be “directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm” (Section 301). This statutory requirement is a regulatory attempt to eliminate management influence over the external auditor and align auditor incentives with those of the board and shareholders. While regulators largely assume that audit committees take responsibility for auditor selection in the post-SOX period (Doty 2011), there exists no archival analysis testing this assumption. Therefore, the effectiveness of this regulation (SOX Section 301) remains uncertain. In this paper, we examine (a) whether contrary to the intent of SOX, managers continue to influence auditor selection decisions in the post-SOX period, and (b) whether this influence subsequently impairs auditor independence as presumed in the legislation. With respect to (a), we use the association between management affiliation and auditor hiring as a way in which to identify management influence over auditor selection. Management affiliation is defined as a prior employment relationship of a manager (i.e., CEO, CFO, controller) with a Big 4 auditing firm. While an affiliation between a