Do Companies With Effective Internal Controls Over Financial Reporting Benefit From Sarbanes–Oxley Sections 302 and 404?

2016 ◽  
Vol 33 (2) ◽  
pp. 200-227 ◽  
Author(s):  
Parveen P. Gupta ◽  
Heibatollah Sami ◽  
Haiyan Zhou
Keyword(s):  
Information Asymmetry ◽  
Financial Reporting ◽  
Capital Markets ◽  
Internal Control ◽  
Trading Volume ◽  
Price Volatility ◽  
Sarbanes Oxley ◽  
Section 302 ◽  
The Impact ◽  
Bid Ask Spreads

Post-SOX (Sarbanes–Oxley Act) academic research on internal control focuses on the characteristics of publicly listed companies disclosing material control weaknesses or the consequences experienced by these companies. However, to date, limited research has empirically examined whether these new disclosures truly enhance “public interest” by promoting “equity” in the capital markets through enhanced information distribution. In this article, we empirically investigate the impact these disclosures have on information asymmetry and related market micro-structure. We hypothesize that both the management’s and the auditor’s reporting on internal control provide outside investors additional and higher quality information about a firm’s future prospects, thereby reducing the information asymmetry in capital markets. Such reduction in information asymmetry should be reflected in decreased bid-ask spreads and price volatility, as well as increased trading volume. Our cross-sectional analyses show that, subsequent to the management’s report on internal control per Section 302, the information environment improves for U.S. firms as manifested by decreased bid-ask spread and price volatility, and increased trading volume. However, we find no similar results subsequent to the auditors’ reporting on a company’s internal control over financial reporting. In our time-series intervention analyses, about 70% of sample firms have experienced significant and permanent reductions in their bid-ask spreads subsequent to the implementation of Section 302 of SOX, in contrast to only 30% of firms subsequent to the implementation of Section 404 of SOX. Our findings point to the public policy issue of whether financial reporting quality of public companies can be improved at a lower cost.

The Impact of Culture on Internal Control Weaknesses: Evidence from Firms That Cross-List in the U.S.

2017 ◽  
Vol 16 (3) ◽  
pp. 119-145 ◽  
Author(s):  
Maria T. Caban-Garcia ◽  
Carmen B. Ríos Figueroa ◽  
Karin A. Petruska
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Power Distance ◽  
Data Availability ◽  
Country Level ◽  
Sarbanes Oxley ◽  
And Control ◽  
Section 302 ◽  
The Impact

ABSTRACT This study addresses the impact of culture on the likelihood of U.S. foreign issuers reporting material weaknesses in internal control over financial reporting (MWICs). Specifically, we explore whether Hofstede's (1980, 2001) country-level dimensions of power distance, individualism, uncertainty avoidance, masculinity, and long-term orientation explain the likelihood of U.S. foreign issuers reporting internal control deficiencies under Section 302 of the Sarbanes-Oxley Act (SOX). To assess whether home country guidance on internal control reporting influences U.S. foreign issuers detecting and reporting MWICs, we identify and control for the adoption of internal control guidance in foreign jurisdictions. Our results show that firms from countries with a high power distance and long-term orientation are more likely to report MWICs. In addition, we find that firms from countries that implement internal control guidance are less likely to report MWICs, suggesting that the effectiveness of U.S. foreign issuers' internal control over financial reporting is influenced by their home countries' regulation and oversight. These results are generally robust to a number of additional sensitivity tests. JEL Classifications: M14; M16; M48. Data Availability: Data are from publicly available sources.

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.

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.

scholarly journals Internal Control Weaknesses and Acquisition Performance

2017 ◽  
Vol 93 (1) ◽  
pp. 235-258 ◽  
Author(s):  
Nancy L. Harp ◽  
Beau Grant Barnes
Keyword(s):  
Stock Returns ◽  
Financial Reporting ◽  
Internal Control ◽  
Cost Benefit ◽  
Acquisition Performance ◽  
Sarbanes Oxley ◽  
Abnormal Stock Returns ◽  
Internal Information ◽  
Internal Control Weaknesses ◽  
Section 302

ABSTRACT This study examines internal control weaknesses (ICWs) reported under Sarbanes-Oxley (SOX) Section 302 in the context of mergers and acquisitions. We predict that problems in an acquirer's internal control environment have adverse operational implications for acquisition performance. We argue that acquirers with low-quality internal information needed to select profitable acquisitions will make poorer acquisition decisions. We also argue that ICWs impede effective monitoring and are likely to hinder integration tasks that are important to acquisition profitability. We find that ICWs disclosed prior to an acquisition announcement predict significantly lower post-acquisition operating performance and abnormal stock returns. Poorer post-acquisition performance is concentrated in ICWs that are expected to impede acquisition activities (i.e., forecasting/valuation, monitoring, and integration). Our findings contribute to the literature linking ineffective internal control over financial reporting to negative operational outcomes. We also contribute to the SOX cost-benefit debate by documenting a previously unidentified benefit of ICW disclosures.

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.

The Impact of Enterprise Resource Planning (ERP) Systems on the Effectiveness of Internal Controls over Financial Reporting

2011 ◽  
Vol 25 (1) ◽  
pp. 129-157 ◽  
Author(s):  
John J. Morris
Keyword(s):  
Financial Reporting ◽  
Enterprise Resource Planning ◽  
Internal Control ◽  
Control Sample ◽  
Resource Planning ◽  
Internal Controls ◽  
Erp Systems ◽  
Individual Account ◽  
Sarbanes Oxley ◽  
The Impact

ABSTRACT: Software vendors that market enterprise resource planning (ERP) systems have taken advantage of the increased focus on internal controls that grew out of the Sarbanes-Oxley (SOX) legislation by emphasizing that a key feature of ERP systems is the use of “built-in” controls that mirror a firm’s infrastructure. They argue that these built-in controls and other features will help firms improve their internal control over financial reporting as required by SOX. This study tests that assertion by examining SOX Section 404 compliance data for a sample of firms that implemented ERP systems between 1994 and 2003. The results suggest that ERP-implementing firms are less likely to report internal control weaknesses (ICW) than a matched control sample of non-ERP-implementing firms. It also finds that this difference exists for both general (entity-wide), and individual (account-level) controls.

scholarly journals Re-evaluating the effectiveness of auditing standard no. 2: longitudinal analysis of restatements and the outcome of auditor litigation in lawsuits filed from 1996 to 2009

2014 ◽  
Vol 11 (2) ◽  
pp. 300-315
Author(s):  
Sebahattin Demirkan ◽  
Ross D. Fuerman
Keyword(s):  
Financial Reporting ◽  
Legal System ◽  
Reporting Quality ◽  
Accurate Identification ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Financial Restatements ◽  
Section 302 ◽  
The Impact ◽  
Audit Effectiveness

We provide evidence of the impact of Auditing Standard No. 2 (“AS 2”), issued pursuant to the Sarbanes-Oxley Act of 2002 (“SarBox”), on the outcome of auditors in financial reporting litigation. Specifically, we focus on the existence of financial restatements and how and why they affected the outcome of the auditor in the financial reporting lawsuits. Our longitudinal method subjected to year-by-year regression analysis 2,059 financial reporting lawsuits filed from 1996 to 2009. Our results indicate that restatements are positively associated with more severe outcomes for the auditor in lawsuits filed in 2002 and in the years after 2004. However, restatements are not significant in lawsuits filed in 2003 and 2004. Pressure from SarBox Section 906 criminal penalties and Section 302 requirements to disclose material weaknesses, coupled with a lack of guidance to distinguish material weaknesses from significant deficiencies, temporarily and indirectly caused the issuance of a large number of restatements that were not material or comprehensible to participants in the legal system. Thus, they were temporarily unable to use the restatements to inform their litigation behavior. However, after the June 17, 2004, release of AS 2, participants in the legal system were again able to use the restatements to inform their behavior. This suggests that AS 2, notwithstanding its inefficiency, necessitating its subsequent superseding by Auditing Standard No. 5 (“AS 5”), increased audit effectiveness and financial reporting quality by facilitating more accurate identification of material weaknesses

The Impact of Internal Audit Function Quality and Contribution on Audit Delay

2014 ◽  
Vol 34 (1) ◽  
pp. 25-58 ◽  
Author(s):  
Mina Pizzini ◽  
Shu Lin ◽  
Douglas E. Ziegenfuss
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
House Of Representatives ◽  
Internal Audit ◽  
Financial Statement ◽  
Internal Auditors ◽  
External Auditors ◽  
Sarbanes Oxley ◽  
The Impact ◽  
Relevant Work

SUMMARY The number of days required to complete financial statement audits (i.e., audit delay) increased significantly with the implementation of Section 404 of the Sarbanes-Oxley Act (SOX, U.S. House of Representatives 2002). As firms' in-house experts on internal control, Internal Audit Functions (IAFs) can substantially affect financial reporting processes and, thus, audit delay. Internal auditors can help management maintain strong internal controls and assist external auditors with financial statement audits. Accordingly, we investigate whether IAF quality and the IAF's contribution to financial statement audits affect audit delay in a sample of 292 firm-year observations drawn from the pre-SOX 404 period. Using survey data from the Institute of Internal Auditors (IIA), we develop a comprehensive proxy for IAF quality; we measure different aspects of IAF quality (e.g., competence, objectivity, fieldwork rigor); and we measure the nature of the IAF's contribution to financial statement audits (independently performed work and direct assistance). Results indicate audit delay is decreasing in IAF quality, and this decrease is driven by IAF competence and fieldwork quality. Delay is four days shorter when IAFs contribute to external audits by independently performing relevant work. High-quality IAFs contribute to financial statement audits by independently performing relevant work, while low-quality IAFs provide direct assistance.

Unexpected Fees and the Prediction of Material Weaknesses in Internal Control Over Financial Reporting

2016 ◽  
Vol 33 (4) ◽  
pp. 485-505 ◽  
Author(s):  
Susan M. Albring ◽  
Randal J. Elder ◽  
Xiaolu Xu
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Fees ◽  
Financial Statement ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
New Material ◽  
Internal Control Weaknesses ◽  
Section 302

We investigate whether prior year unexpected audit fees help predict new material weaknesses in internal control over financial reporting reported under Section 404 of the Sarbanes–Oxley Act (SOX). Predicting material weaknesses may be useful to investors and other financial statement users because these disclosures have adverse economic impacts on disclosing firms. Unexpected fees are significantly associated with material weaknesses reported under Section 404, even after controlling for Section 302 disclosures and other factors associated with internal control weaknesses. Unexpected fees are associated with company-level weaknesses but are not significantly associated with account-specific weaknesses, consistent with differences in the nature and severity of the two types of material weaknesses. Our results are consistent with unexpected audit fees containing information on unobserved audit costs and client control risks, which help predict future internal control weaknesses.

scholarly journals Internal Control Weakness and Stock Price Crash Risk

2015 ◽  
Vol 31 (4) ◽  
pp. 1289 ◽  
Author(s):  
Siwoon Hong ◽  
Jong Eun Lee
Keyword(s):  
Information Asymmetry ◽  
Financial Reporting ◽  
Internal Control ◽  
Stock Price ◽  
Crash Risk ◽  
Section 404 ◽  
Material Weakness ◽  
The Impact

Considering that stock price crashes are positively associated with opaque financial reporting and that effective internal control over financial reporting is essential for reliable and transparent financial reporting, it is thus vital to establish and maintain effective internal control over financial reporting. In this paper, we investigate the impact of internal control weakness on stock price crash risk, using the disclosures under Section 404 of the 2002 SarbanesOxley Act. We find that material weakness in internal control over financial reporting increases information asymmetry by producing unreliable and/or opaque financial reporting, subsequently resulting in a stock price crash. Our study provides evidence that ineffective internal control over financial reporting is an indicator of future stock price crashes.

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