An Intertemporal Analysis of Audit Fees and Section 404 Material Weaknesses

Abstract

SUMMARY The objective of this study is to perform an intertemporal examination of audit fees paid to public accounting firms in association with the presence and subsequent remediation of a Section 404 material weakness. We examine a large sample of Section 404 audit opinions and audit fees over a four-year period (2004–2007) and find that audit fees decline for companies that remediate a material weakness, but show that the corresponding fee reductions do not occur instantaneously. Further, despite these observed fee reductions for remediating companies, we find that audit fees are 19 percent higher three years after the initial remediation as compared to a sample of companies who never report an adverse 404 opinion. We also find that fee premiums are nearly double for companies reporting consecutive adverse 404 opinions. Finally, we note that companies with a more severe company-level weakness pay a premium that is more than twice that of companies with an account-level weakness.