Indicators of audit fees and fraud classification: impact of SOX

Purpose – The purpose of this paper is to compare the effect of corporate governance variables and fraud litigation on audit fees both before and after the implementation of the Sarbanes-Oxley (SOX) Act in 2002. Design/methodology/approach – The paper utilizes a sample of firms that had litigation proceedings filed against them for fraudulent financial reporting, and compare these firms to a sample of non-fraud firms in the pre-and post-SOX period. First, the authors examine indicators of audit fees using the Simunic model. Next, the authors develop a logistic regression model with corporate governance variables and other financial control variables in order to identify the characteristics of firms that are accused of fraud in the pre-and post-SOX period. Findings – The paper identifies specific components of corporate governance that are positively related to audit fees and which subsequently aid in classifying companies subject to fraud litigation. The most successful logistic regression model for 2005 (post-SOX) is 64.4 per cent accurate in distinguishing firms litigated for fraud, while the most successful model for 2001 (pre-SOX) is 61.4 per cent accurate in distinguishing such firms. Originality/value – The research design and findings assist in providing additional evidence about the association between the effectiveness of the corporate governance structure and the external auditor in assessing the risk of fraud.