scholarly journals Internal Control Weakness and Bank Loan Contracting: Evidence from SOX Section 404 Disclosures

2011 ◽  
Vol 86 (4) ◽  
pp. 1157-1188 ◽  
Author(s):  
Jeong-Bon Kim ◽  
Byron Y. Song ◽  
Liandong Zhang
Keyword(s):  
Internal Control ◽  
Bank Loan ◽  
Control Problems ◽  
Section 404 ◽  
Loan Contracts ◽  
Loan Spread ◽  
Sarbanes Oxley ◽  
Loan Contracting ◽  
Internal Control Weaknesses ◽  
Loan Contract

ABSTRACT Using a sample of borrowing firms that disclosed internal control weaknesses (ICW) under Section 404 of the Sarbanes-Oxley Act, this study compares various features of loan contracts between firms with ICW and those without ICW. Our results show the following. First, the loan spread is higher for ICW firms than for non-ICW firms by about 28 basis points, after controlling for other known determinants of loan contract terms. Second, firms with more severe, company-level ICW pay significantly higher loan rates than those with less severe, account-level ICW. Third, lenders impose tighter nonprice terms on firms with ICW than on those without ICW. Fourth, fewer lenders are attracted to loan contracts involving firms with ICW. Finally, our within-firm analyses show that banks increase loan rates charged to ICW firms after their disclosure of internal control problems and that banks reduce loan rates after firms remediate previously reported ICW.

Internal Control Quality and Audit Pricing under the Sarbanes-Oxley Act

2008 ◽  
Vol 27 (1) ◽  
pp. 105-126 ◽  
Author(s):  
Rani Hoitash ◽  
Udi Hoitash ◽  
Jean C. Bedard
Keyword(s):  
Internal Control ◽  
Risk Adjustment ◽  
Initial Period ◽  
Audit Fees ◽  
Control Problems ◽  
Section 404 ◽  
Audit Pricing ◽  
Audit Risk ◽  
Sarbanes Oxley ◽  
Section 302

This paper extends prior research on audit risk adjustment by examining the association of audit pricing with problems in internal control over financial reporting, disclosed under Sections 404 and 302 of the Sarbanes-Oxley Act [SOX]. While studies of auditors' responses to internal control risk provide mixed evidence, it is important to re-examine this issue using data on specific client problems not available prior to SOX. As a baseline, we first establish a strong association of audit fees with internal control problems disclosed in the first year of implementation of Section 404, consistent with prior research (e.g., Raghunandan and Rama 2006). We then address two issues on which prior results are contradictory. In a broadly based sample of accelerated filers, we find that audit pricing for companies with internal control problems varies by problem severity, when severity is measured either as material weaknesses versus significant deficiencies, or by nature of the problem. Also, while audit fees increase during the 404 period, our tests show less relative risk adjustment under Section 404 than under Section 302 in the prior year. Further examining intertemporal effects, we find that companies disclosing internal control problems under Section 302 continue to pay higher fees the following year, even if no problems are disclosed under Section 404. Overall, our findings provide detailed insight into audit risk adjustment during the initial period of SOX implementation.

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.

Earnings Management of Firms Reporting Material Internal Control Weaknesses under Section 404 of the Sarbanes-Oxley Act

2008 ◽  
Vol 27 (2) ◽  
pp. 161-179 ◽  
Author(s):  
Kam C. Chan ◽  
Barbara Farrell ◽  
Picheng Lee
Keyword(s):  
Earnings Management ◽  
Internal Control ◽  
Internal Controls ◽  
Corporate Disclosure ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Potential Benefits ◽  
Internal Control Weaknesses ◽  
Reported Earnings

SUMMARY: The main objectives of the Sarbanes-Oxley Act of 2002 are to improve the accuracy and reliability of corporate disclosure. Under Section 404 of the Sarbanes-Oxley Act, the external auditor has to report an assessment of the firm’s internal controls and attest to management’s assessment of the firm’s internal controls. Material weaknesses in internal controls must be disclosed in the auditor and management reports. The objective of this study is to examine if firms reporting material internal control weaknesses under Section 404 have more earnings management compared to other firms. The results provide mild evidence that there are more positive and absolute discretionary accruals for firms reporting material internal control weaknesses than for other firms. Since the findings of ineffective internal controls by auditors under Section 404 may cause firms to improve their internal controls, Section 404 has the potential benefits of reducing the opportunity of intentional and unintentional accounting errors and of improving the quality of reported earnings.

SOX 404 Reported Internal Control Weaknesses: A Test of COSO Framework Components and Information Technology

2009 ◽  
Vol 23 (2) ◽  
pp. 1-23 ◽  
Author(s):  
Bonnie K. Klamm ◽  
Marcia Weidenmier Watson
Keyword(s):  
Information Technology ◽  
Internal Control ◽  
Negative Impact ◽  
Internal Controls ◽  
First Year ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Assessment And Monitoring ◽  
Internal Control Weaknesses

ABSTRACT: This paper examines internal controls, from both an information technology (IT) and non-IT perspective, in relation to the five components of the Committee of Sponsoring Organization's Internal Control-Integrated Framework (COSO 1992), as well as the achievement of one of COSO's three objectives-reporting reliability. Our sample consists of 490 firms with material weaknesses reported under Sarbanes-Oxley Section 404 during the first year of compliance. We classify the weaknesses by COSO component and as IT-related or non-IT-related. Our results support the interrelationships of the COSO Framework. The results also show that the number of misstated accounts is positively related to the number of weak COSO components (i.e., scope) and certain weak COSO components (i.e., existence). Firms with IT-related weak components report more material weaknesses and misstatements than firms without IT-related weak components, providing evidence on the pervasive negative impact of weak IT controls, especially in control environment, risk assessment, and monitoring.

The Persistence in the Association between Section 404 Material Weaknesses and Financial Reporting Quality

2013 ◽  
Vol 33 (1) ◽  
pp. 93-116 ◽  
Author(s):  
Emma-Riikka Myllymäki
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Financial Reporting Quality ◽  
Control Problems ◽  
Section 404 ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
History Of

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.

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.

The Adoption and Consequences of COSO 2013

2021 ◽  
Author(s):  
Amanuel F Tadesse ◽  
Gina Cavalier Rosa ◽  
Robert J. Parker
Keyword(s):  
Information Technology ◽  
Internal Control ◽  
Internal Controls ◽  
Lower Probability ◽  
Control Problems ◽  
Timely Manner ◽  
Sarbanes Oxley ◽  
Enterprise Risk ◽  
Control Framework ◽  
Internal Control Weaknesses

COSO has developed frameworks for firms to improve their internal controls with the objective of reducing fraud and managing enterprise risk. The frameworks are widely used by firms and their auditors to comply with the internal control requirements of the Sarbanes-Oxley Act (SOX). We investigate two issues involving the most recent COSO internal control framework (COSO 2013): the determinants of a firm's decision to adopt it in a timely manner; and the consequences of adoption on internal controls. In our sample, firms that report internal control problems under SOX 404, especially firms with information technology (IT) problems, are likely to be late adopters. Regarding the consequences of adoption, for late adopters, we find that firms using the revised COSO framework have a lower probability of reporting weaknesses in IT-related controls. We also find evidence that COSO 2013 adoption is helpful in remediating internal control weaknesses.

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).

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.

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