Audit Pricing and Internal Control Disclosures Among Non-Accelerated Filers

In this paper we examine the association of audit fees with disclosures regarding internal control effectiveness under Section 302 of the Sarbanes Oxley Act of 2002 (SOX). In contrast to previous studies, we focus on non-accelerated filers, whose eventual compliance with the costly provisions of SOX Section 404 internal control reporting has become a contentious topic. Despite the fact that auditors are not required to evaluate internal controls under Section 302, we find that companies disclosing problems under Section 302 pay higher audit fees, consistent with greater audit effort and/or risk premia. Further, we observe that auditors apply risk-based audit pricing consistent with problem severity and management's assertion of disclosure control effectiveness. Our evidence also suggests that while non-accelerated filers did not have to comply with Section 404 of SOX, their audit fees significantly increased as accelerated filers began compliance. While prior research examining accelerated filers pre/post Section 404 implementation shows less risk adjustment in audit pricing in the first year of 404 compliance, we do not find a change in risk adjustment for non-accelerated filers. A fee change model reveals that companies remediating internal control problems disclosed in 2003 continue to pay higher fees in 2004. Finally, we observe that in 2004, Big 4 audit fees are higher for both continuing and new clients, and companies switching away from Big 4 firms experience a reduction in their audit fees