The Effect of Section 404 of the Sarbanes-Oxley Act on Financial Reporting Quality

SUMMARY This study examines whether Sarbanes-Oxley (SOX) Section 404 material weakness (MW404) disclosures are predictive of future financial reporting quality. I find evidence that for companies with a history of MW404s, the likelihood of misstatements in financial information continues to be significantly higher for two years after the last MW404 report compared to companies without a history of reported MW404s. The magnitude of the effect decreases non-linearly with decreasing speed. The findings further imply that the reason for the misstatement incidences is the unacknowledged pervasiveness of control problems. In particular, it appears that in many cases, the future misstatements are unrelated to the MW types disclosed in the last MW404 report, suggesting that some MW types are unacknowledged and, hence, control problems are even more pervasive than what was identified. Overall, the findings of this study highlight the importance of discovering and disclosing material weaknesses in internal control over financial reporting.

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Did the 1999 NYSE and NASDAQ Listing Standard Changes on Audit Committee Composition Benefit Investors?

The Accounting Review ◽

10.2308/accr-51716 ◽

2017 ◽

Vol 92 (6) ◽

pp. 187-212 ◽

Cited By ~ 17

Author(s):

Seil Kim ◽

April Klein

Keyword(s):

Financial Reporting ◽

Audit Committee ◽

Research Question ◽

Reporting Quality ◽

Audit Committees ◽

Financial Reporting Quality ◽

Difference In Differences ◽

Listed Firms ◽

Sarbanes Oxley ◽

Independent Audit

ABSTRACT In December 1999, the SEC instituted a new listing standard for NYSE and NASDAQ firms. Listed firms were now required to maintain fully independent audit committees with at least three members. In July 2002, the U.S. Congress legislated these standards through the Sarbanes-Oxley Act. Our research question is whether all investors benefited from the 1999 new rule. Using both an event study and a difference-in-differences methodology, we find no evidence of higher market value or better financial reporting quality resulting from this rule.

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Investor Perceptions of Government Deregulation: Evidence from Section 404 of the Sarbanes-Oxley Act

Accounting Horizons ◽

10.2308/horizons-17-176 ◽

2020 ◽

Author(s):

Benjamin W Hoffman ◽

John L. Campbell ◽

Jason L. Smith

Keyword(s):

Financial Reporting ◽

Government Regulation ◽

Abnormal Returns ◽

Reporting Quality ◽

Internal Controls ◽

Litigation Risk ◽

Section 404 ◽

Fraud Risk ◽

Sarbanes Oxley ◽

Public Company

We investigate the stock market's reaction to events leading up to the Securities and Exchange Commission's (SEC) and Public Company Accounting Oversight Board's (PCAOB) 2007 regulatory changes that reduced the scope of and documentation requirements for assessments of firms' internal controls over financial reporting (ICFR), as required by Section 404 of the Sarbanes-Oxley Act. The stated goal of these regulations was to reduce firms' and auditors' compliance costs with mandatory ICFR assessments, while maintaining the effectiveness of these assessments. We examine abnormal returns surrounding key dates leading to the passage of these regulations and offer two main findings. First, investors reacted negatively on key event dates, suggesting that investors viewed the regulations as likely to reduce financial reporting quality rather than to drive firm and audit efficiencies. Second, this negative market reaction is larger when ICFR effectiveness should matter most - when firms are more complex, have higher litigation risk, and greater fraud risk. In additional analysis, we find that restatements increase in the post-regulation time period, consistent with investors' concerns that the effect of the legislation would be a reduction in ICFR effectiveness. Overall, our results may imply that investors prefer stronger government regulation when it comes to the assessments of a firm's internal controls over financial reporting.

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Influence of the Sarbanes-Oxley Act on Financial Reporting Quality: An Overview of EU Firms Cross-Listed in the USA

10.21203/rs.3.rs-198068/v1 ◽

2021 ◽

Author(s):

Ujkan Bajra ◽

Rrustem Asllanaj

Keyword(s):

Financial Reporting ◽

Internal Control ◽

Reporting Quality ◽

Financial Reporting Quality ◽

Publicly Traded ◽

Publicly Traded Companies ◽

Sarbanes Oxley ◽

Novel Approach ◽

The Us ◽

The Usa

Abstract This paper investigate whether compliance with the Sarbanes–Oxley Act of 2002 (SOX) Sect. 302 (financial reporting) and 404 (internal controls) enhances financial reporting quality (FRQ). This study focuses on EU publicly traded companies that are cross-listed in the US markets. Using a novel approach with respect to operationalization of the SOX, the empirical research integrated into this paper advances the understanding of financial reporting quality for both practitioners and policymakers. The study argues that financial reporting quality increased after SOX entered into force but, notably, we find that FRQ improves with compliance with SOX302 but not with SOX404. Examination of the latter relationship at the subsection level also reveals that compliance with certain SOX requirements is not satisfactory. We find that three out of six subsections of SOX302 are directly associated with financial reporting, while subsections (1), (5) and (6) of SOX302 are not related with FRQ, indicating that the management team, albeit not entirely, provides a reliable financial reporting systems. We also find that compliance with some SOX404’s subsections has been relatively low (i.e. subsections (1) and (3) of SOX404)), suggesting that corporations have not established and are not maintaining suitable internal control systems over financial reporting.

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Managers' Strategic Reporting Judgments in Audit Negotiations

Auditing A Journal of Practice & Theory ◽

10.2308/ajpt-51306 ◽

2015 ◽

Vol 35 (1) ◽

pp. 47-64 ◽

Cited By ~ 4

Author(s):

Helen Brown-Liburd ◽

Arnold M. Wright ◽

Valentina L. Zamora

Keyword(s):

Financial Reporting ◽

Audit Committee ◽

Reporting Quality ◽

Financial Reporting Quality ◽

Dyadic Relationship ◽

The Past ◽

Sarbanes Oxley ◽

Negotiation Tactics ◽

Relative Bargaining Power ◽

Triadic Relationship

SUMMARY Prior research has largely characterized audit negotiations as a dyadic relationship between auditors and managers. However, the Sarbanes-Oxley Act (SOX) substantially enhances the audit committee's oversight responsibilities for the financial reporting and auditing processes. Thus, negotiations post-SOX may be viewed as a triadic relationship that now involves the audit committee with the authority to scrutinize audit negotiations. Consistent with auditors considering their relative bargaining power and expectations of counterpart behavior, Brown-Liburd and Wright (2011) find that auditors are most contending when the audit committee is strong and the past relationship is contentious. We extend Brown-Liburd and Wright (2011) by examining the joint effects of these factors on managers' pre-negotiation judgments. We posit that rather than mirror auditor behavior, managers make different judgments because they have a different perspective and set of incentives than do auditors. Prior research suggests that managers are more flexible, more accurately determine their counterpart's goals and limits, and are more likely to use certain negotiation tactics than auditors. Further, managers have incentives to maximize the current outcome while maintaining their firm's reporting reputation. As such, managers will be less aggressive in responding to a contentious past auditor relationship, particularly in the presence of a strong audit committee that may ask difficult questions and potentially intervene against their favor. However, managers will act more aggressively to capitalize on a cooperative past auditor relationship, particularly in the presence of a weak audit committee that is passive or persuadable. To examine these two boundary conditions, we conduct an experiment with 137 experienced CFO/controllers. We find strong evidence supporting our expectations that managers act as if both the audit committee and the auditor jointly play important roles in ensuring high financial reporting quality. JEL Classifications: M41; M42.

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Audit Partner Rotation and Financial Reporting Quality

Auditing A Journal of Practice & Theory ◽

10.2308/ajpt-50753 ◽

2014 ◽

Vol 33 (3) ◽

pp. 59-86 ◽

Cited By ~ 31

Author(s):

Barri Litt ◽

Divesh S. Sharma ◽

Thuy Simpson ◽

Paul N. Tanyi

Keyword(s):

Financial Reporting ◽

Rotation Period ◽

Reporting Quality ◽

Financial Reporting Quality ◽

Sarbanes Oxley ◽

Big 4 ◽

Novel Approach ◽

Partner Change ◽

Audit Partner Rotation ◽

The U.S

SUMMARY: Audit partner rotation has received considerable attention globally and in the U.S. since the Sarbanes-Oxley Act of 2002 accelerated the rotation period from seven to five years and expanded the cooling-off period from two to five years. However, research on the effects of audit partner rotation on financial reporting quality in the U.S. is virtually non-existent, largely due to the absence of publicly available information on audit partners. Using a novel approach to determine audit partner rotation, we investigate the effect of rotation on financial reporting quality in the U.S. We find evidence of lower financial reporting quality following an audit partner change. Specifically, we find lower financial reporting quality during the first two years with a new audit partner relative to the final two years with the outgoing partner. We find the lower financial reporting quality to be more prevalent for larger clients. Further analyses suggest the initial year post-rotation presents audit challenges for Big 4 partners, which persist for at least three years for non-Big 4 partners. Audit challenges also appear greater for city-level non-industry specialist auditors and smaller audit offices. We discuss the implications of our results for regulators, policymakers, and the profession at large.

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CFO/CEO-Board Social Ties, Sarbanes-Oxley, and Earnings Management

Accounting Horizons ◽

10.2308/acch-50028 ◽

2011 ◽

Vol 25 (3) ◽

pp. 537-557 ◽

Cited By ~ 40

Author(s):

Gopal V. Krishnan ◽

K. K. Raman ◽

Ke Yang ◽

Wei Yu

Keyword(s):

Earnings Management ◽

Financial Reporting ◽

Social Ties ◽

Reporting Quality ◽

Financial Reporting Quality ◽

Board Independence ◽

Sarbanes Oxley ◽

Time Period ◽

The Board Of Directors

SYNOPSIS Prior research suggests that the efficacy of a formally independent member of the board of directors could be undermined by social ties with the CEO. In this study, we examine the relation between CFO/CEO-board social ties and earnings management over the 2000–2007 time period. Our results suggest that CFOs/CEOs picked more socially connected directors in the post-Sarbanes-Oxley Act (SOX) time period (possibly as a way out of the mandated independence requirements). Our results also suggest a positive relation between CFO/CEO-board social ties and earnings management. Still, the increase in managerial/board risk aversion since SOX appears to have negated the effect of social ties on earnings management in the post-SOX period. Board independence and financial reporting quality remain topics of ongoing interest. The study is important in advancing our understanding of the role of social ties in earnings management.

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Does Attestation of the effectiveness of Internal Control over Financial Reporting Discourage Earnings Management? Evidence from China

Accounting and Finance Research ◽

10.5430/afr.v7n4p1 ◽

2018 ◽

Vol 7 (4) ◽

pp. 1

Author(s):

Li Dang ◽

Qiaoling Fang

Keyword(s):

Earnings Management ◽

Financial Reporting ◽

Internal Control ◽

Reporting Quality ◽

Financial Statements ◽

Financial Reporting Quality ◽

Chinese Government ◽

Chinese Firms ◽

Public Firms ◽

Sarbanes Oxley

To improve financial reporting quality, the Chinese government issued the Basic Standard for Enterprise Internal Control in 2008 and other related guidelines/regulations in the following years (hereafter China SOX). The scope of China SOX is broader but similar to Section 404 of the Sarbanes-Oxley Act (SOX) in the U.S. Formal adoptions of China SOX requires management and external auditor’s report on the effectiveness of internal control over financial reporting (ICFR). A company’s ICFR, if effective, should provide reasonable assurance that the company’s financial statements are reliable and prepared in accordance with the applicable accounting standards. The purpose of this study is to investigate whether China external auditor attestation of ICFR discourage earnings management, an indicator of financial reporting quality. By analyzing a sample of Chinese public firms during 2011 to 2013, we find that: (1) Chinese firms that disclose audited ICFR reports exhibit lower earnings management than firms that do not; (2) Chinese firms that are mandated to disclose audited ICFR reports exhibit lower earnings management than firms that voluntarily disclose audited ICFR reports. Our empirical results seem to suggest that attestation of the effectiveness of ICFR discourages earnings management and therefore improve financial reporting quality.

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Internal Control Weakness and Managerial Myopia: Evidence from SOX Section 404 Disclosures

ACRN Journal of Finance and Risk Perspectives ◽

10.35944/jofrp.2019.8.1.004 ◽

2019 ◽

Vol 8 (1) ◽

pp. 71-83 ◽

Cited By ~ 1

Author(s):

Amy E. Ji

Keyword(s):

Financial Reporting ◽

Internal Control ◽

Investment Decisions ◽

Reporting Quality ◽

Internal Controls ◽

Financial Reporting Quality ◽

Section 404 ◽

Managerial Myopia ◽

Internal Control Weaknesses ◽

The Impact

Problem/ Relevance: Managerial myopia is an important issue of interests to academics, practitioners, and regulators as managers have been condemned for their obsession with short-term earnings and myopic investment decisions that sacrifice firms’ long term value for shareholders. This article contributes by examining whether the quality of firms’ internal controls over financial reporting (ICFR) is associated with managerial myopia. Research Objective/ Questions: The purpose of this study is to examine whether managers in firms reporting material internal control weaknesses (ICW) under Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 engage in myopic behaviors more than those in firms without reporting ICW. Methodology: The study uses the logit regression model to investigate a sample obtained from Compustat for the period of 2005-2013. Major Findings: The study finds a positive association between internal control weaknesses reported by auditors under Section 404 of the SOX and managerial short-termism which is measured by the probability of cutting R&D expenses in the current year from the previous year. Implications: Whereas prior studies mostly examine the impact of internal controls on accounting quality, this study demonstrates the implication of internal controls beyond financial reporting quality by showing an association between internal control quality and managerial myopia. Future research may further investigate the association between firms’ financial reporting quality and managerial investment decisions.

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Non-Audit Services in Audit Committee Interlocked Firms, Financial Reporting Quality, and Future Performance

Journal of Accounting Auditing & Finance ◽

10.1177/0148558x211015552 ◽

2021 ◽

pp. 0148558X2110155

Author(s):

Linna Shi ◽

Siew Hong Teoh ◽

Jian Zhou

Keyword(s):

Financial Reporting ◽

Audit Committee ◽

Board Member ◽

Detrimental Effect ◽

Reporting Quality ◽

Auditor Independence ◽

Financial Reporting Quality ◽

Sample Period ◽

Future Performance ◽

Sarbanes Oxley

We investigate whether board-interlocked firms via an audit committee (AC) board member exhibit correlated non-audit service (NAS) purchases, and whether financial reporting quality and future firm performance vary with the amount of correlated NAS purchases from the AC interlock. We find that AC interlocked firms have positively correlated total NAS and three NAS subtypes—Tax, Assurance, and Other—in the overall sample period from 2000 to 2016, and in each of the subperiods pre- and post-SOX (Sarbanes–Oxley Act). Firms with a larger NAS component that is explained by the AC interlock tend to exhibit lower financial reporting quality. We also find evidence that firms with higher AC interlocked NAS purchases are associated with lower future performance, although this association exists only in the pre-SOX period. Overall, the evidence suggests that greater NAS purchases among AC interlocked firms can have a detrimental effect on financial reporting quality and auditor independence. While these detrimental effects are concentrated in the pre-SOX period when there were less restrictions on NAS purchases, we find some evidence that the association with lower financial reporting quality persists in the post-SOX period.

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