Financial Reporting Consequences of Exempting Low-Revenue Issuers from the Internal Control Audit Requirement

In 2020, the SEC amended Exchange Act Rule 12b-2, exempting most issuers with less than $100 million in annual revenue from the requirement to obtain an audit of internal controls over financial reporting (ICFRs) under Section 404(b) of the Sarbanes-Oxley Act. The amendment prompted extensive discussion and debate among regulators, issuers, audit firms, and academics. We consider the consequences of the amendment. We find that exempted issuers rarely obtain an ICFR audit voluntarily, suggesting that affected issuers do not perceive an ICFR audit to be cost-beneficial. Using a difference-in-differences research design, we find no evidence that issuers under the revenue threshold experienced a decline in ICFR quality (i.e., increased material weaknesses) or financial reporting quality (i.e., increased misstatements, abnormal accruals) compared to issuers just over the threshold. Our analyses suggest that the expanded exemption was welcomed by most issuers and that the amendment did not significantly impair financial reporting quality.

Keywords: SOX Section 404(b); Internal Control Audits; Compliance Benefits

Suggested Citation: Suggested Citation

McCallen, Jennifer and Schmardebeck, Roy and Shipman, Jonathan E. and Whited, Robert Lowell, Financial Reporting Consequences of Exempting Low-Revenue Issuers from the Internal Control Audit Requirement (November 01, 2024). Available at SSRN: https://ssrn.com/abstract=3420787 or http://dx.doi.org/10.2139/ssrn.3420787