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SEPTEMBER 2010        RSSPrint PrintEller College on Facebook FacebookPrint Twitter     

Research Report
The Cost of Independence: The Consequences of Going Above and Beyond Sarbanes-Oxley Regulations

Kirsten Cook
Assistant Professor of
Accounting Kirsten
Cook looks beyond

By Liz Warren-Pederson

A decade ago, in the immediate aftermath of the Enron and WorldCom accounting scandals, regulators decided to limit the types of non-audit services that audit firms could provide to client companies as one mechanism for preventing aggressive financial reporting.

“The idea was that perhaps the audit firm would be more willing to look the other way if it had other financial ties to the client company,” explained assistant professor of accounting Kirsten Cook.

One non-audit service that the Sarbanes-Oxley Act (SOX) didn’t ban was taxation services, but, said Cook, “A large number of firms that could purchase tax services from their audit firms chose not to, effectively going beyond the legal requirements. We wanted to learn the consequences of going beyond the SOX regulations to bolster auditor independence.”

Cook and coauthor Thomas C. Omer of Texas A&M University presented their findings at the American Accounting Association’s annual conference in San Francisco last month.

“We found that the firms that went beyond the regulatory limits actually suffered negative consequences for doing so,” Cook said. “Our results reveal that sample firms’ tax rates increased in the year after terminating or substantially decreasing purchases of tax services from their auditors. In other words, these companies reported more tax expense to their shareholders and paid more taxes to the IRS.”

Cook and Omer theorize that these results are due to the new provider's lack of familiarity with the client's tax-planning opportunities or lack of expertise at generating tax-avoidance strategies.

Knowing that, Cook said, “If firms were willing to have their tax-related costs go up, were these reforms effective? Was the economic bond between audit firms and client companies that regulations were trying to prevent really a problem?”

He and Omer studied data before and after firms dismissed their auditors as tax-service providers and did not find evidence that compromised independence was a problem. Specifically, Cook noted, “Our results indicate that the quality of firms’ financial reporting didn’t change when they stopped paying tax fees to their auditors.” But, he hastened to point out, “We don’t want to rely on a result where we didn’t find anything. So, we’re currently investigating other measures of financial-reporting quality to strengthen our story.”

He and Omer are continuing their line of investigation on the topic, which represents one of two main tracks in Cook’s research. In addition to taxation—an area of specialty that evolved from his experience in public accounting practice—he also has work underway in earnings management.

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