Costs and benefits of internal control audits: evidence from M&A transactions

Todd D. Kravet (), Sarah E. McVay () and David P. Weber ()
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Todd D. Kravet: University of Connecticut
Sarah E. McVay: University of Washington
David P. Weber: University of Connecticut

Review of Accounting Studies, 2018, vol. 23, issue 4, No 5, 1389-1423

Abstract: Abstract To inform the debate on the merits of internal control audits, we examine managers’ decisions to temporarily exempt newly acquired businesses from Section 404 of the Sarbanes-Oxley Act. We document that managers are more likely to elect the exemption when expected compliance costs are higher, such as when acquisitions are larger and occur later in the year. We find only modest evidence that managers use the exemption to avoid scrutiny of value-destroying deals. Exemption use, however, is associated with negative post-acquisition outcomes, including lower return-on-assets and higher likelihoods of goodwill impairments and financial statement restatements. These results comport with compliance providing benefits by facilitating timely identification and correction of control problems in the newly acquired business. Finally, we document negative abnormal stock returns at the time exemption use is announced and over the subsequent 3 years, suggesting that investors view exemption use negatively and that their initial price reactions are incomplete.

Keywords: Internal control over financial reporting; Merger and acquisition integration (search for similar items in EconPapers)
JEL-codes: G30 G34 K22 M4 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (7)

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DOI: 10.1007/s11142-018-9468-9

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