Do management reports on internal control over financial reporting improve financial reporting?

Sections 404a and 404b of the Sarbanes–Oxley Act require management and external auditors, respectively, to report on the adequacy of a company’s internal control over financial reporting (ICFR). Larger public firms were first required to file a management report and have an external audit of ICFR in 2004. Smaller public firms were first required to file a management report on ICFR in 2007 but are exempt from the attestation requirement. We investigate the distinct effect of management reports on financial reporting quality. We find that management reports on ICFR improve reporting quality and demonstrate that there are financial reporting benefits from the management report requirement on its own without attestation.     

The association between human resource investment in IT controls over financial reporting and investment efficiency

This study investigates the association between human resource investment in information technology (IT) controls over financial reporting and its investment efficiency. To conduct the analysis, it uses novel hand-collected data on the number of IT control personnel. In particular, it uses the ratio of (1) the number of IT control personnel, (2) the number of IT control personnel who are certified public accountants to the total number of employees in a firm, and (3) the natural logarithm of average working experience of IT control personnel in months as a proxy for human resource investment in IT controls. This study finds that such investment is negatively associated with the firm's abnormal investment, suggesting that investing in IT control personnel enhances a firm's investment efficiency. Furthermore, not only quantitative but also qualitative investment in IT control personnel improves investment efficiency. We also find that the association between human resource investment in IT controls and a firm's investment efficiency is more pronounced for firms with lower financial reporting quality and information environment. The results of this study provide useful implications for management, regulators, and market participants, as they demonstrate the positive role of investment in IT control personnel on the firm's internal decision.     

The effect of auditors’ internal control opinions on loan decisions

We examine the effect of internal control reports on lending officers’ assessments of a company’s creditworthiness. We suggest that an adverse internal control opinion can undermine the assurance provided by an unqualified opinion on financial statements taken as a whole and have a negative affect on lenders’ assessments. In addition, we investigate whether auditor size plays a role in determining the effect on lenders’ judgments.     

The effect of internal control deficiencies on the usefulness of earnings in executive compensation

Since SOX 404 disclosures are informative about earnings, and due to the widespread practice of using earnings-based measures in executive compensation, this study examines whether reports of internal control material weaknesses (ICMW) under SOX 404 influence firms' reliance on earnings in tying executive pay to performance. Using 391 (366) firm-year observations with reported ICMW and 3648 (3138) firm-year observations for CEOs (CFOs) reporting NOMW under SOX 404, we find a decreased strength in the association between earnings and executives' (CEO and CFO) compensation when the firm reports an ICMW, and as the number of reported ICMW increases. In addition, we find this decreased weight on earnings for the more severe Company-Level than Account- Specific material weaknesses. Our study suggests that the ICMW report under SOX 404 provides incremental information for executive compensation beyond that contained in reported earnings.     

The Impact of Disclosures of Internal Control Weaknesses and Remediations on Investors' Perceptions of Earnings Quality

We hypothesize and find that firms making SOX‐mandated disclosures of material weaknesses in internal control over financial reporting (ICOFR) exhibit lower investor‐perceived earnings quality (IPEQ) than nondisclosers. We measure IPEQ using e‐loading, a market‐returns–based representation of earnings quality developed by Ecker, Francis, Kim, Olsson, and Schipper (2006). Firms do not exhibit decreases in IPEQ after initially disclosing material weaknesses. This is consistent with investors having anticipated ICOFR strength based on observable firm characteristics. However, firms exhibit increases in IPEQ after receiving their first clean audit reports that confirm the remediation of previously disclosed weaknesses. This indicates that, although investors do not find initial weakness disclosures to be incrementally informative, SOX motivates firms to remediate weak controls and provides a venue for credible remediation disclosures, thus enhancing investors' perception of financial reporting reliability. These findings are consistent with the existence of regulatory benefits associated with SOX's internal control disclosure and audit requirements.     

The effect of IFRS for SMEs on the financial reporting environment of private firms: an exploratory interview study

I investigate how the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs) contributes to the development of private firm financial reporting. I interview a sample of leading accounting experts from 24 jurisdictions around the globe to understand the role of private firm financial reporting and financial transparency in their jurisdiction as well as the importance of IFRS for SMEs. I find significant variation across jurisdictions in my sample and document that IFRS for SMEs predominantly influenced private firm financial reporting and transparency by serving as a blueprint for national regulatory reforms. In some jurisdictions, IFRS for SMEs has also been adopted as an optional reporting framework. Direct firm-level adoption of IFRS for SMEs has been low in these jurisdictions with the exception of South Africa where it seems to be used relatively widely. Based on my response data, I suggest some potential rationales for my findings and discuss potential reasons for the observed cross-jurisdiction variation in private firm financial transparency and IFRS for SMEs adoption.     

The impact on stock prices of deferral and elimination of internal control audit requirement for small firms

This paper examines the cumulative market reaction to the events related to deferral of internal control audit requirement under the Sarbanes-Oxley Act of 2002 and its elimination under the Dodd-Frank Act of 2010 for nonaccelerated filers (small firms). We document that small firms experienced negative cumulative abnormal returns around these events; and the differences between the cumulative abnormal returns for small firms and the two control groups (accelerated and large accelerated filers) were negative and significant at the 1% level. These results support the notion that market participants value the reliability of financial information irrespective of the firm size. Within the small firms, we find no firm characteristic significantly explains the market reaction to the events considered. That is, all small firms lost market value in reaction to the events that delayed and eliminated their internal control audit requirement.