Unintended consequences of Section 201 of the Sarbanes-Oxley Act

Abstract

This paper provides an economic framework to analyze the consequences of Section 201 of the Sarbanes-Oxley Act (SOX), which prohibits auditors from providing many non-audit services (NAS) to their public company audit clients. In the model auditors strategically choose costly audit effort and audit report that involves balancing the expected litigation loss with the loss of future consulting fees that can be earned from providing NAS to the same client. I show that Section 201 of the SOX could result in auditors’ issuing audit reports faithfully, but that only comes at a cost of decreasing audit effort. If the adverse direct impact on the synergy between audit and NAS has to be significant in order to ensure faithful reporting, this regulatory change might also decrease the reliability of audit reports and the efficiency gain that can be obtained from an audit. My analysis thus shows that Section 201 of the SOX may have some unintended negative consequences.