SOX 404: Unintended Consequences

Matthew Harrison, University of Redlands

Abstract

Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) requires that the management of each public company assess the adequacy of internal controls, and the public accountants issue an attestation report. The legislators of SOX intended to reduce accounting misstatements through stronger internal controls and promote management and auditor accountability. Recent evidence also indicates significant unintended consequences from SOX, including compliance costs higher than originally anticipated and a negative effect on auditor-client relationships including auditor resignations and dismissals. In this paper recent press reports reporting unintended consequences are summarized. Furthermore, data relating to auditor changes in September 2003 and September 2004 are compared, finding that audit relationships terminated in 2004 are of significantly larger, more profitable, and more widely-traded companies, and that companies now tend to switch to significantly smaller audit firms, or fail to find an immediate replacement for a departing auditor.