Technology Advancements for Whistleblowing Reporting Platforms and Employees’ Decision to Blow the Whistle

Section 302 of the Sarbanes-Oxley Act requires public companies to maintain platforms for employees to report questionable practices anonymously. Technological advancements have now enabled many firms to incorporate technology into their whistleblowing platforms. An online platform is often promoted as a medium that offers more anonymity than the traditional phone platform. Furthermore, developments in artificial intelligence have enhanced the creation of virtual agents, which can run 24/7/365 at a low cost. Using an experimental paradigm, this study found no significant difference in perceived anonymity between online reporting and phone reporting. The phone platform attracted more reporting intention when a live agent handled reports because witnesses feel more support when talking to a live agent over the phone. However, the witnesses were more likely to report to an online platform when a virtual agent handled the reports because witnesses believed that it is more efficient and provides greater control while reporting.

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

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.

Material Weakness in Internal Controls and Stock Price Crash Risk

We investigate the association between material weakness in internal controls (MW) disclosed under Section 302 of the Sarbanes–Oxley Act of 2002 (SOX) and future stock price crash risk. We argue that relative to firms with effective internal controls, firms with MW have lower financial reporting precision. The lower reporting precision (a) increases divergence of investor opinion with regard to firm valuation and (b) facilitates managers’ withholding of negative information, which increases the information asymmetry between managers and outside investors. We hypothesize that both these effects increase the probability of a future stock price crash. We find empirical evidence consistent with our prediction. In additional analyses, we document that the positive association between MW and crash risk is primarily driven by company level rather than by account-specific weaknesses, increases with the number of material weaknesses, and intensifies during the financial crisis. In addition, we find that both the existence and the disclosure of MW incrementally affect crash risk, and that MW facilitates managers’ withholding of bad news. Finally, we fail to find consistent evidence of a significant relation between MW disclosed under Section 404 of SOX and crash risk.

Internal Control Weaknesses and Acquisition Performance

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.

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

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.

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

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 Effect of CEO Social Influence Pressure and CFO Accounting Experience on CFO Financial Reporting Decisions

SUMMARY The purpose of this study is to test the effects of inappropriate CEO social influence pressure and CFO accounting experience on CFOs' reporting judgments and decisions. Specifically, we use a sample of 69 highly experienced public company CFOs to evaluate the extent that inappropriate compliance or obedience pressure from the CEO to revise financial reporting to meet an earnings target affects CFO revision decisions. The results indicate that compliance pressure (a request) and obedience pressure (an order) from the CEO significantly (and similarly) increase CFO willingness to revise their initial inventory adjustments. Although both types of pressure from CEOs impact CFOs' financial reporting decisions, compliance pressure did not create increased levels of perceived pressure. The results also reveal an inverse relation between CFO accounting experience and revision of the initial estimate. Finally, CFOs who acquiesce to CEO pressure maintain their personal responsibility for the adjustment, contrary to obedience theory, but consistent with the intent of SOX Section 302 certification requirements.

An Analysis and Taxonomy of Disclosure Controls and Procedures Effectiveness

SUMMARY With the passage of the Sarbanes-Oxley Act, there has been much discussion and analysis of Section 404 dealing with management's and the external auditor's evaluation of internal controls over financial reporting (ICFR). However, Section 302 of the Act requires management to evaluate their disclosure controls and procedures (DC&P) and report on the effectiveness of such controls in their 10-Q and 10-K filings. This paper explains the SEC's differentiation of ICFR and DC&P and attempts to report on the effectiveness of DC&P utilizing the Audit Analytics database. The data show that DC&P have been ineffective, as reported by management in their 10-K filings, ranging from a low of 13.75 percent to a high of 33.91 percent of observations over the 11-year period from 2004 through 2014. The paper concludes with potential research issues related to DC&P.