The following post comes to us from Sarah Rice and David Weber, both of the Department of Accounting at the University of Connecticut.
In the paper, How Effective is Internal Control Reporting under SOX 404? Determinants of the (Non-) Disclosure of Existing Material Weaknesses, forthcoming in the Journal of Accounting Research, we examine the effectiveness of SOX 404 internal control reports in identifying existing material control weaknesses, as well as the determinants of the relative effectiveness of those reports across firms. While SOX 404 has received significant attention, largely due to the perceived burden of the associated compliance costs, how reliably the resulting reports identify weaknesses has remained largely overlooked in the academic literature. We address this void by studying a sample of firms that restate previously-issued financial statements to correct misstatements and that can be identified as having had existing control weaknesses during the time of their misstatements. We examine the internal control reports that accompanied the original (misstated) financial statements to determine whether firms reported their control weaknesses as required. Thus, our paper differs from previous research such as Doyle et al. [2007] and Ashbaugh et al. [2007] in that we are able to separate the reporting of internal control weaknesses from their underlying existence. Because weaknesses exist for all of our sample firms, we are able to focus on the reporting of those weaknesses and thus provide evidence on the factors that affect detection and disclosure. We sharpen the interpretation of our evidence by also conducting analyses that distinguish between factors that affect detection versus those that affect disclosure.
