The Effect of Sarbanes-Oxley Act on Auditor Conservatism Toward Newly Accepted Clients<br>Seminar 2: The Joint Effect of Audit Quality and Legal Regime on the Use of Real versus Accrual-based Earnings Management: International Evidence

This study investigates whether auditors'conservatism towards newly acquired clients has changed after the enactment of Sarbanes-Oxley Act (SOX) based on a large sample of listed U.S. firms for the period 1999 through 2004. We predict that the higher litigation and reputation risks borne by SOX increase the demand for conservative accounting choices for Big 4 auditors' new clients relative to their ongoing clients in the post-SOX period. Consistent with our prediction, newly acquired clients of Big N auditors exhibit significantly higher levels of conservatism relative to ongoing clients from 2002 to 2004. To corroborate our findings, we examine whether the heightened conservatism among new clients is driven by clients formerly audited by Arthur Andersen. However, our evidence suggests that financial reporting conservatism increased unilaterally for all new clients in 2002, indicating that, irrespective ofthe Andersen-Enron affair, Big 4 auditors demand higher level of conservatism from all of their new clients.
This study investigates whether and how firms' REM activities are influenced by the strength of country-level legal regime, and examines whether the role of Big 4 auditors on mitigating REM is different between countries with strong and weak legal regimes. It also analyzes the effect of legal regime and audit quality on the relative use of REM over AEM. We first find that the intensity of REM increases as legal regime strengthens. However, this increased use of REM is mitigated by higher audit quality of Big 4 auditors, especially in strong legal regime countries due to their increasing concerns about litigation risk and reputations in those countries. We also find that the relative intensity of REM over AEM increases with stronger legal regime because more firms switch from AEM to REM due to higher relative cost of AEM in those countries, and that this relative intensity is mitigated by higher audit quality because Big 4 auditors are concerned about REM as well as AEM. These findings are robust to a battery of sensitivity tests.