Audit Fees Post-Sox: An Auction Model

Research shows that audit fees have increased after the SOX ban on providing non-audit services (NAS) to audit clients, but the reasons behind it have been unclear. Using an auction-modeling approach, this study aims to bridge this gap by providing a theoretical explanation for this empirical finding. Specifically, the paper analyzes the impact of the ban imposed in SOX/Title II on providing both audit services and NAS to audit clients. The study builds and compares an auction setting where auditors can compete for both auditing and NAS (the pre-SOX setting) with one where auditors can compete on only one of the two (the post-SOX setting). The model shows that NAS fees should have increased after SOX. The intuition behind this result is that the SOX-imposed ban on providing both NAS and audit services to the same clients has lessened the competition in the NAS auction. Next, the study demonstrates that audit fees will be higher in the post-SOX setting than the pre-SOX one. The intuition behind this finding is that in the post-SOX regime, to ensure that audit firms will participate in the audit auction even if they are inefficient, clients need to compensate the winner in the audit auction for giving up the NAS auction. The study also demonstrates that if clients’ budgets would stay the same, or increase, NAS prices would increase to reflect reduced competition. If, on the other hand, NAS budgets are reduced then, the study demonstrates that there is a threshold budget beyond which, the utility of audit firms would improve, and below it decrease. The intuition behind this result stems from the tradeoff between the increase in audit fees and the reduced NAS revenues, thus, leading to a threshold above which the auditors’ utility increases, and below which it decreases.