International Implications of the Cost of Compliance with the External Audit Requirements

International Implications of the Cost of Compliance

with the External Audit Requirements of Section

404of Sarbanes –Oxley

Sak Bhamornsiri &Robert Guinn &

Richard G.Schroeder

Published online:23August 2008#International Atlantic Economic Society 2008

Abstract The Sarbanes –Oxley ACT (SOX)was effective for many large panies for fiscal years ending on or after December 15,2004.Some,cross listed,non U.S.,companies must comply with the provisions of Section 404(404)of SOX for fiscal periods ending on or after July 15,2006.The purposes of this study are to review the implications of SOX 404,to assess SOX 404’s potential impact on world-wide securities regulation,assess the impact of SOX 404on external audit fees for the initial group of filers during the first 2years it was effective and assess SOX 404’s prospective economic impact on foreign companies that cross list their securities in the U.S.Our finding indicated that audit fees increased by an average of 65%for the initial group of filers in the first year SOX 404was effective and by .9%in the second year.This increase was reflected in a .5%decrease in earnings for these companies.We conclude that although similar results might be expected for foreign companies that cross list,the implementation costs do not provide sufficient reason to weaken or eliminate SOX 404’s requirements at this time.

Keywords Audit fees .Compliance cost .Cross listing .International implications .Sarbanes –Oxley

JEL M41

In July 2002,U.S.President George W.Bush signed into law the Sarbanes –Oxley Act (SOX)that imposes a number of corporate governance rules on publicly traded Int Adv Econ Res (2009)15:17–29

DOI 10.1007/s11294-008-9178-3

S.Bhamornsiri :R.Guinn :R.G.Schroeder (*)

Department of Accounting,Belk College of Business,University of North Carolina at Charlotte,Charlotte,NC,USA

e-mail:dickschr@

S.Bhamornsiri

e-mail:sbhamorn@

R.Guinn

e-mail:reguinn@

18S.Bhamornsiri et al. companies in the United States,and foreign companies wishing to list their securities on U.S.stock exchanges.SOX was created in an attempt to protect investors by improving the accuracy and reliability of corporate disclosures.The act covers issues such as establishing a public company accounting oversight board,increasing auditor independence,corporate responsibility and enhancing financial disclosure. One key element of this legislation is to require a report on the internal controls a company has in place in order to ensure compliance with its provisions.Specifically, Section404(404)mandates that CEOs and CFOs must file periodic reports outlining the internal control over financial reporting and a certification of the disclosures contained in the annual report.SOX was effective for companies meeting the definition of accelerated filers(having an equity market capitalization of over$75 million and filing a report with the SEC)for fiscal years ending on or after December15,2004;consequently December31,2004was the effective filing date for most of these panies must comply with SOX’s provisions for fiscal periods ending on or after July15,2006if their market capitalization exceeds$75million.In addition,foreign non-accelerated filers are subject to an incremental filing requirement that will result in full compliance for fiscal periods ending on or after December15,2008(discussed below).

SOX404requires substantial compliance costs as discussed below.Some of the internal compliance costs are not directly measurable but one significant component of these costs is external audit fees.The purposes of this study are to review the implications of SOX404,to assess SOX404’s potential impact on world-wide securities regulation,assess the impact of SOX404on external audit fees for the initial group of filers(during the first2years it was effective)and to assess SOX404’s prospective economic impact on foreign companies that cross list their securities in the U.S. Background

During the early2000s,dozens of major panies either went bankrupt or faced extreme financial difficulties.These included such familiar names as Enron, WorldCom,Xerox,Global Crossing and Halliburton Oil Services.As a result, investors lost billions of dollars,jobs vanished,and thousands of people lost their entire retirement savings.Subsequently,“corporate reform”became a watchword In addition to the scandals,the cavalier attitude of the executives of some of the failed companies further unsettled the U.S.and the world.For example,in congressional testimony,Jeffrey Skilling,CEO of Enron,maintained that detailed financial reporting and disclosure vigilance was the proper domain not of a CEO,but of Enron’s accountants and lawyers.Similarly,Bernie Ebbers,the CEO of WorldCom,alleged that he was totally unaware of his CFO’s financial reporting wrongdoing.1Public unrest over these issues resulted in hearing before the United States Congress,and on April25,2002,the House of Representatives passed the Oxley Bill.On July15,2002,the Senate passed the Sarbanes Bill.Together these two bills became known as the Sarbanes–Oxley Act of2002.

1Apparently neither the public nor the courts were swayed by these arguments as both Skilling and Ebbers were convicted of fraud in2006.