Dynamics of deterioration in internal control reported under SOX 404

Chunhua Chen, Tianze Li, Ruiqing Shao and Steven Xiaofan Zheng

International Review of Economics & Finance, 2019, vol. 61, issue C, 228-240

Abstract: We examine why many firms disclose internal control weaknesses (ICW) under section 404 of Sarbanes-Oxley Act after previously reporting effective internal control (IC). We find that about half of the cross-sectional ICW determinant variables either do not change significantly from Year T-1 to Year T or change in a direction that is not expected to cause IC deterioration. The reported deterioration in IC can be attributed to increases in audit fee, management turnover, restatement, financial distress, firm size, and decrease in financial activities. Consistent with an agency hypothesis that managers try to manipulate the IC process when firm performance declines, the reported deterioration in IC is also associated with poor stock returns in the year before disclosure. ICW disclosure is more likely when poor stock return is combined with higher sensitivity of executive compensation to stock price change.

Keywords: Sarbanes-oxley act; Internal control weakness; Deterioration; Restatement; Agency problem; Benchmark adjusted returns; Executive compensation (search for similar items in EconPapers)
JEL-codes: G12 G14 G30 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:61:y:2019:i:c:p:228-240

DOI: 10.1016/j.iref.2019.02.009

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