An exploration of the choice to comply voluntarily with SOX section 404(b)

2019 ◽  
Vol 35 (1) ◽  
pp. 93-110
Author(s):  
Alan Blankley ◽  
David Hurtt ◽  
Jason MacGregor
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Small Businesses ◽  
Small Companies ◽  
Section 404 ◽  
Content Type ◽  
Sarbanes Oxley ◽  
Financial Perspective ◽  
The Law ◽  
Several Delays

Purpose Central to the Sarbanes–Oxley Act was a requirement that every company have an audit of its internal control over financial reporting. However, there were concerns that this requirement was overly burdensome, from a financial perspective, for small businesses. This concern promoted several delays in enforcing the law for small companies and ultimately caused congress to permanently exempt small businesses. Yet, there are some small companies that voluntarily elect to comply with the law. The purpose of this paper is to explore why these companies elect to incur these costly audits. Design/methodology/approach Using a sample of 5,834 non-accelerator US firms, this paper uses a robust logistic regression model to examine why some firms comply voluntary with SOX Section 404(b). Findings This study shows that small companies getting audits of internal controls may be doing so to restore investor confidence after reporting failures, to appear credible prior to raising funds, as a response to organizational changes, or in anticipation of being required to comply. Practical implications This study provides regulators with an improved understanding of when it is necessary to implement mandatory rather than voluntary guidance. Originality/value This study is the first to document why a client would voluntarily comply with SOX Section 404 (b).

Section 404 Compliance and Financial Reporting Quality

2010 ◽  
Vol 24 (3) ◽  
pp. 441-454 ◽  
Author(s):  
Albert L. Nagy
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Financial Statements ◽  
Securities And Exchange Commission ◽  
Small Companies ◽  
Section 404 ◽  
Financial Reports ◽  
Sarbanes Oxley

SYNOPSIS: This study examines whether the Sarbanes-Oxley Act Section 404 (S404) compliance efforts lead to higher quality financial reports. An objective of S404 is to encourage companies to devote adequate resources and attention to their internal control systems, which should lead to more reliable financial statements. A natural laboratory of S404 compliance and noncompliance companies exists because the Securities and Exchange Commission has deferred the S404 compliance date for small companies (nonaccelerated filers). A logistic regression model is estimated using a sample of companies surrounding the S404 compliance threshold to measure the S404 compliance effect on the likelihood of issuing materially misstated financial statements. The results show a significant and negative relation between S404 compliance and issuance of materially misstated financial statements, and suggest that the S404 regulation is meeting its objective of improving the quality of financial reports.

Auditor Attestation under SOX Section 404 and Earnings Informativeness

2012 ◽  
Vol 32 (1) ◽  
pp. 61-84 ◽  
Author(s):  
Lucy Huajing Chen ◽  
Jayanthi Krishnan ◽  
Heibatollah Sami ◽  
Haiyan Zhou
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Control Sample ◽  
Audit Fees ◽  
Test Sample ◽  
Section 404 ◽  
Earnings Informativeness ◽  
Sarbanes Oxley ◽  
Audit Reports ◽  
Section 302

SUMMARY Section 404 of the Sarbanes-Oxley Act requires managers to assess, and their auditors to express an opinion on, the effectiveness of internal controls over financial reporting (ICFR). Policymakers expect the ICFR audits to enhance the credibility of firms' financial statements. Prior research argues that audit characteristics that enhance the credibility of financial reporting are associated with stronger earnings-return associations. We examine whether earnings accompanied by the first-time Section 404 ICFR reports were associated with higher informativeness compared with earnings in the prior year when only financial statement audit reports were available. We conduct our analysis for a test sample of accelerated filers with clean ICFR reports and clean previous Section 302 disclosures. Using a difference-in-differences approach, we compare the change in earnings informativeness for the test sample with that for a control sample of non-accelerated filers. We find that earnings informativeness for companies with clean internal control reports was greater in the Section 404 adoption year than in the previous year, while there was no change in earnings informativeness for the non-accelerated filers. Also, there is no difference in the increase in earnings informativeness across firms with small and large compliance costs (measured by change in audit fees), suggesting that both groups benefited from the Section 404 ICFR audits.

Observed effectiveness of the COSO 2013 framework

2019 ◽  
Vol 16 (1) ◽  
pp. 31-45
Author(s):  
Ifeoma Udeh
Keyword(s):  
Control Systems ◽  
Internal Control ◽  
Design Methodology ◽  
Control Process ◽  
Regression Analyses ◽  
Section 404 ◽  
Content Type ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Practical Implications

Purpose This paper aims to examine the effectiveness of the Committee of Sponsoring Organization’s 2013 Framework, by investigating how the number of auditor-reported material weaknesses compares for Early-, Timely- and Late-adopters of the framework, and how the number of auditor-reported material weaknesses changed for Early- and Timely-adopters following their adoption of the framework. Design/methodology/approach The paper uses regression analyses based on a sample of US firms subject to Sarbanes-Oxley Act Section 404(b). Findings Timely-adopters of the 2013 Framework continued to exhibit fewer instances of auditor-reported material weaknesses than Late-adopters, even though they had a marginal increase in the number of auditor-reported material weaknesses, in the post-2013 Framework period. Practical implications The findings suggest that the effectiveness of the 2013 Framework may lie in the iterative nature of the internal control process, and as firms remedy deficiencies they or their auditors identify, they will continuously improve the effectiveness of their internal control systems. Originality/value Unlike existing literature, this paper uses data from the pre-2013 Framework, transition and post-2013 Framework periods to examine changes in the number of auditor-reported material weaknesses, thus differentiating between Early-, Timely- and Late-adopters of the 2013 Framework. It also shows the effect of adopting the 2013 Framework on the number of auditor-reported material weaknesses.

The Impact of SOX Section 404 Internal Control Quality Assessment on Audit Delay in the SOX Era

2006 ◽  
Vol 25 (2) ◽  
pp. 1-23 ◽  
Author(s):  
Michael L. Ettredge ◽  
Chan Li ◽  
Lili Sun
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Small Sample ◽  
Impact Factors ◽  
Section 404 ◽  
Material Weakness ◽  
Control Quality ◽  
Sarbanes Oxley ◽  
Specific Material ◽  
The Impact

This study analyzes the impact of internal control quality on audit delay following the implementation of the Sarbanes-Oxley Act (2002) (SOX). Unlike prior studies of audit delay that obtain information about internal control strength via surveys, or use fairly crude proxies for internal control quality, our study employs external auditor assessments of internal control over financial reporting (ICOFR) that are publicly disclosed in SEC 10-K filings under SOX Section 404. Thus, the empirical evidence provided in this study is both timely and reliable (i.e., not subject to small sample bias or weak proxies). Consistent with our expectation, we find that the presence of material weakness in ICOFR is associated with longer delays. The types of material weakness also matter. Compared to specific material weakness, general material weakness is associated with longer delays. Additional analyses indicate that companies with control problems in personnel, process and procedure, segregation of duties, and closing process experience longer delays. After controlling for other impact factors, this study also documents a significant increase in audit delay associated with the fulfillment of the SOX Section 404 ICOFR assessment requirement. This suggests that Section 404 assessments have made it more difficult for firms to comply with the SEC's desire to shorten 10-K filing deadlines. Our finding thus supports and helps explain the SEC's decisions in 2004 and 2005 to defer scheduled reductions in 10-K filing deadlines (from 75 days to 60 days) for large, accelerated filers.

SOX Section 404 Material Weakness Disclosures and Audit Fees

2006 ◽  
Vol 25 (1) ◽  
pp. 99-114 ◽  
Author(s):  
K. Raghunandan ◽  
Dasaratha V. Rama
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Fees ◽  
Internal Controls ◽  
Fiscal Year ◽  
Section 404 ◽  
Control Material ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
The Mean

Section 404 of the Sarbanes-Oxley Act and Auditing Standard No. 2 (PCAOB 2004) require management and the auditor to report on internal controls over financial reporting. Section 404 is arguably the most controversial element of SOX, and much of the debate around the costs of implementing section 404 has focused on auditors' fees (Ernst & Young 2005). In this paper, we examine the association between audit fees and internal control disclosures made pursuant to section 404. Our sample includes 660 manufacturing firms that have a December 31, 2004 fiscal year-end and filed the section 404 report by May 15, 2005. We find that the mean (median) audit fees for the firms in our sample for fiscal 2004 is 86 (128) percent higher than the corresponding fees for fiscal 2003. Audit fees for fiscal 2004 are 43 percent higher for clients with a material weakness disclosure compared to clients without such disclosure; however, audit fees for fiscal 2003 are not associated with an internal control material weakness disclosure (in the 10-K filed following fiscal 2004). We also find that the association between audit fees and the presence of a material weakness disclosure does not vary depending on the type of material weakness (systemic or non-systemic).

Borrowers' Accounting Information and the Quality of Banks' Loan Portfolios

2020 ◽  
Author(s):  
Carlo Maria Gallimberti
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Public Funding ◽  
Section 404 ◽  
Loan Portfolio ◽  
Loan Contracts ◽  
Loan Portfolios ◽  
Sarbanes Oxley ◽  
Positive Effect

I examine the relation between borrowers' financial reporting (FR) and the quality of banks' loan portfolios. This relation is theoretically ambiguous as better FR improves banks' monitoring of loans but also grants more creditworthy borrowers cheaper access to alternative public funding, increasing competition and creating adverse selection problems for banks. Using the adoption of Section 404 of the Sarbanes-Oxley Act to identify improvements in borrowers' FR, I find an overall positive effect of FR on banks' lending: the quality of loans extended to borrowers subject to Section 404 improves relative to the quality of loans extended by the same bank to other borrowers exempted from Section 404. Additional tests examining borrowers' internal control over FR and loan contracts' characteristics confirm that improved monitoring and screening are both responsible for the higher loan portfolio quality. Overall, my study highlights unexplored consequences of companies' FR on the quality of banks' assets.

Control Self-Assessment and Costs of Compliance with Sarbanes-Oxley Section 404

2019 ◽  
Vol 31 (3) ◽  
pp. 5-24 ◽  
Author(s):  
Lawrence J. Abbott ◽  
Susan Parker ◽  
Gary F. Peters ◽  
Theresa J. Presley
Keyword(s):  
Control Systems ◽  
Financial Reporting ◽  
Internal Control ◽  
Audit Fees ◽  
Negative Association ◽  
Management Control ◽  
Section 404 ◽  
Self Assessment ◽  
Internal Auditor ◽  
Sarbanes Oxley

ABSTRACT Control self-assessment (CSA) represents the practice of making operational-level managers responsible for internal control monitoring. We investigate the association between the use of CSA and certain costs incurred in maintaining internal control systems and complying with regulatory requirements. We find a negative association between CSA and external audit fees paid for the audit of internal control over financial reporting. Moreover, we find an incremental fee reduction resulting from the interaction between CSA and Section 404 assistance provided to the external auditor by the internal auditor. Additionally, we find a negative association between the use of CSA and some costs of the internal audit's own evaluation of operational and financial controls for managerial purposes. In sum, our study suggests that CSA can lessen at least some internal control costs while reducing control risk as proxied by external costs of internal control compliance. We discuss implications for broader management control systems.

Corporate Governance and Internal Control over Financial Reporting: A Comparison of Regulatory Regimes

2009 ◽  
Vol 84 (3) ◽  
pp. 839-867 ◽  
Author(s):  
Udi Hoitash ◽  
Rani Hoitash ◽  
Jean C. Bedard
Keyword(s):  
Corporate Governance ◽  
Financial Reporting ◽  
Internal Control ◽  
Audit Committee ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Financial Expertise ◽  
Financial Expert ◽  
Section 302

ABSTRACT: This study examines the association between corporate governance and disclosures of material weaknesses (MW) in internal control over financial reporting. We study this association using MW reported under Sarbanes-Oxley Sections 302 and 404, deriving data on audit committee financial expertise from automated parsing of member qualifications from their biographies. We find that a lower likelihood of disclosing Section 404 MW is associated with relatively more audit committee members having accounting and supervisory experience, as well as board strength. Further, the nature of MW varies with the type of experience. However, these associations are not detectable using Section 302 reports. We also find that MW disclosure is associated with designating a financial expert without accounting experience, or designating multiple financial experts. We conclude that board and audit committee characteristics are associated with internal control quality. However, this association is only observable under the more stringent requirements of Section 404.

Investor reactions to restatements conditional on disclosure of internal control weaknesses

2018 ◽  
Vol 19 (3) ◽  
pp. 423-439 ◽  
Author(s):  
Yiwen Li ◽  
You-il Park ◽  
Jinyoung Wynn
Keyword(s):  
Stock Returns ◽  
Financial Reporting ◽  
Internal Control ◽  
Private Information ◽  
Abnormal Returns ◽  
Content Type ◽  
Sarbanes Oxley ◽  
Financial Restatements ◽  
Abnormal Stock Returns ◽  
Internal Control Weaknesses

Purpose The purpose of this paper is to investigate investor reactions to financial restatements conditional on disclosures of internal control weaknesses under Section 404 of the Sarbanes-Oxley Act. Design/methodology/approach The research uses cumulative abnormal stock returns (CARs) as a proxy for investor reactions. Restatements and internal control reports are available on audit analytics. Multivariate regression analyses were used for testing. Findings Using a sample of restating firms whose original misstatements are linked to underlying internal control weaknesses, the research finds that cumulative abnormal returns for firms disclosing internal control weaknesses in a timely manner is negative in a three-day window around the restatement announcements. The finding indicates that restatements with early disclosure of internal control weaknesses provide more persuasive evidence of the ineffectiveness of a firm’s internal control over financial reporting, rather than early disclosure lowering the information asymmetry between a firm and investors. Research limitations/implications This study employs CARs to examine the market reaction to restatements conditional on disclosure of internal control weaknesses. Practical implications Further study on reactions by creditors who have access to private information on firms could extend the implications of the finding. Originality/value The study contributes to the existing research by documenting that early disclosure of material weaknesses in internal control affects investors’ reactions to financial restatements.

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