How Effective Is Internal Control Reporting under SOX 404? Determinants of the (Non‐)Disclosure of Existing Material Weaknesses

Rice, Sarah; Weber, David P.

doi:10.1111/j.1475-679x.2011.00434.x

Cited by 345 publications

(249 citation statements)

References 59 publications

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“…The presence of 1 We use the disclosure of a material weakness to identify the year that a material weakness is discovered and documented, since the effects of discovery and disclosure cannot be unraveled. This is consistent with Rice and Weber (2012). Also, in secondary tests, we use a sample of firms with no internal control deficiencies as an alternative control sample.…”

Section: Introductionmentioning

confidence: 65%

Material Weaknesses in Tax-Related Internal Controls and Last Chance Earnings Management

Gleason

Pincus

Rego

2017

The Journal of the American Taxation Association

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ABSTRACT:We investigate the consequences of tax-related internal control material weaknesses (ICMWs) for financial reporting. We hypothesize that the presence of ineffective controls over the tax function makes earnings management through the income tax accrual (both income-increasing and income-decreasing) easier to implement relative to firms with effective controls. We also predict that the remediation of tax-related ICMWs has the effect of constraining earnings management through the tax accrual. The results provide support for our predictions. We also find that last chance earnings management via tax-related ICMWs is concentrated in the early years of our sample, during the initial SOX implementation period. Our results suggest that tax-related ICMWs were initially associated with greater tax-expense management but that SOX internal control assessments subsequently improved the quality of financial reporting by reducing opportunities for tax-expense management.

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Section: Introductionmentioning

confidence: 65%

Material Weaknesses in Tax-Related Internal Controls and Last Chance Earnings Management

Gleason

Pincus

Rego

2017

The Journal of the American Taxation Association

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“…First, we do not have information on the identities of CDS traders and are thus unable to control for counterparty risk, which is of particular concern during the financial crisis. Second, we rely on information about internal control quality as disclosed by companies, but many companies may not disclose such information in a timely manner (Rice and Weber 2012). Therefore, we may under-or over-estimate the effect of internal control MWs on CDS spreads.…”

Section: Discussionmentioning

confidence: 99%

Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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i Internal Control Quality and Credit Default Swap SpreadsSYNOPSIS: This paper presents the first study on the effects of internal control quality on derivatives pricing. Specifically, we utilize data from the credit default swap (CDS) transactions of well-monitored companies to examine the relationship between the quality of internal control and the cost of debt. The CDS data we employ are advantageous for our analysis because CDS contracts are comparatively more homogeneous, standardized, and liquid than bank loans and public bonds. We find that CDS spreads increase around the disclosure of internal control material weaknesses (MWs) and that, all else equal, companies experiencing MWs with respect to internal control have higher CDS spreads than companies with effective internal control.Moreover, companies with company-level MWs have higher CDS spreads than those with less severe, account-specific MWs. In addition, remediating internal control MWs is associated with a decrease in CDS spreads. Our study offers a new perspective on the relationship between the quality of internal control and the cost of debt. These conflicting results may be due to heterogeneous characteristics and measurement issues in using bank loans and public bonds to measure credit spreads. Covenants, embedded optionalities (such as callability and convertibility), and other complicating factors associated with bank loans and public bonds may distort the relationship between credit risk and internal control quality. Furthermore, because information on bank loans is only available when companies receive new loans, researchers are relegated to three-or four-year windows in their observations of changes in loan spreads (Dahilwal et al. 2011). By contrast, CDS contracts are relatively homogeneous and standardized, and CDS spreads reflect credit risk better than loan or 3 bond spreads (Shivakumar et al. 2011;Callen et al. 2009) because the CDS market is not as plagued with the liquidity issues that affect the public bond and bank loan markets. Therefore, CDS spreads are a superior means of examining the impact of internal control quality on credit pricing.We expect CDS spreads to be positively related to internal control MWs for two reasons.First, a firm that is experiencing MWs in internal control suggests that its financial reporting may be unreliable, which thereby increases the perceived information risk from the perspective of a credit investor. Such information risk related to unreliable information sources leads an investor to charge a higher credit risk premium (e.g., Duffie and Lando 2001;Lambert et al. 2007).Second, internal control MWs make it easier for managers to misappropriate a company's assets, which increases the default risk. For example, Skaife et al. (2013) report that the profitability of insider trading is significantly greater in firms with internal control MWs, which suggests the risk of expropriation of outside shareholders when there are weak internal controls.In an examination of the period from November 15, 2004, ...

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“…Some of these studies use U.S. data from before SOX (Srinidhi and Gul 2007;Gul, Jaggi, and Krishnan 2007;Krishnan, Su, and Zhang 2011;Omer, Bedard, and Falsetta 2006;Dickins 2008;Causholli, Chambers, and Payne 2014;Bell et al 2015). However, there are others that find evidence of loss of independence using more recent U.S. data (Rice and Weber 2012;Ye 2012), or data from Australia (Ye, Carson, andSimnett 2011), or New Zealand (Wang andHay 2013). More details of these studies are provided in Table 2.…”

Section: Issue 3: Ratio Of Non-audit To Audit Feesmentioning

confidence: 99%

Audit Fee Research on Issues Related to Ethics

Hay

2017

Current Issues in Auditing

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SUMMARY Audit fees are related to important ethical issues for auditors. There has been increasing research on audit fees recently, including research on potential ethical risks regarding audit fees, which helps to illuminate some of these professional issues. The International Ethics Standards Board for Accountants (IESBA) is very interested in this area and asked me to prepare a paper reviewing the relevant research. This summary reviews research that became available from 2006 to 2016 on four issues related to audit fees—fee level, dependence, non-audit fees, and firms that have a significant non-audit services business. Examining the research shows consistent evidence about two issues, namely that audit fees for new engagements are lower and that non-audit services affect independence in appearance. There are two further issues about which there is some concern. First, there are occasional studies reporting evidence that non-audit services provided by an auditor are associated with a loss of independence indicated by lower audit quality, even though most research does not support this conclusion. Second, there has been recent concern about growth in non-audit services to non-audit clients and there is some preliminary evidence that audit quality is lower in firms that have more extensive non-audit businesses. In general, although audit fee research does not convey a message that there are widespread ethical problems, the body of research shows that there are some risk areas.

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How Effective Is Internal Control Reporting under SOX 404? Determinants of the (Non‐)Disclosure of Existing Material Weaknesses

Cited by 345 publications

References 59 publications

Material Weaknesses in Tax-Related Internal Controls and Last Chance Earnings Management

Material Weaknesses in Tax-Related Internal Controls and Last Chance Earnings Management

Internal Control Quality and Credit Default Swap Spreads

Audit Fee Research on Issues Related to Ethics

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