The Effect of Sarbanes-Oxley Act on Book-Tax Differences and How They Relate to Audit Fees and Firm Size

• In Event: Audit II

Abstract

This study investigates whether the relation between audit pricing and firm size has changed with regards to book-tax differences in a pre- and post-Sarbanes Oxley Act (SOX) setting. Lots of studies investigate the relationship between book-tax differences and tax avoidance. However, there are limited investigations in relationship between book-tax differences and audit fees. During the pre-SOX period, the disclosure of non-audit services such as tax fees was not required, firms choose to disclose them voluntarily could lead to self-selection bias. The SOX was able to eliminate the bias because it requires auditors to disclose tax fees (Halperin and Lai, 2015). Consistent with Hanlon et al. (2012), my results show a strong positive correlation between the book-tax differences and audit fees. Also, I find that book-tax difference during the post-SOX period is strongly related with audit fees compared to those during the pre-SOX period. I also did a size-based analysis on large firms and small firms, the results show that during pre-SOX period, large firms have greater book-tax difference than smaller firms; however, in the post-SOX period, smaller firms are the ones driving a large gap between book and taxable income. Furthermore, the subgroups of negative book-tax difference and positive book-tax difference show results that the coefficient of positive book-tax difference is significantly positive during the pre-SOX period, but the coefficient on negative book-tax difference is not. This suggests that overstated earnings impact audit fees greatly before SOX. During the post-SOX period, negative book-tax difference is the one that stays at a higher-level of significance, indicating the overstated rather than understated earnings are more influenced by the Sarbanes-Oxley Act.

Author

• Yu Long, Kent State University