The Cost Stickiness of Information Technology Material Weaknesses: An Intertemporal Comparison between IT-Related and Other Material Weaknesses

Abstract

PCAOB inspections of audit firms help drive audit focus and costs, and with the PCAOB’s emphasis on internal control audit work beginning in 2010, internal control weaknesses (ICW) have become of even greater concern. IT-related material weaknesses have emerged as particularly significant with PCAOB reports in 2008 and 2012 highlighting on-going deficiencies in audit work related to IT controls, and the 2015 brief noting the PCAOB’s intention to maintain focus on audit deficiencies that appear recurring. We explore how the focus on ICW affects audit fees and how the complexity of contemporary enterprise systems results in a persistence of audit fee premiums post-remediation. We conduct a study of audit fee premium differences associated with various categories of material weaknesses in internal controls. Using propensity score matched samples, we provide evidence that the fee premium charged to firms reporting IT-related material weaknesses (ITMW), after remediation, lingers longer than the fee premium imposed on firms reporting non-IT entity-level material weaknesses (NITELMW), or firms reporting account-specific material weaknesses (ASMW). Moreover, we show that the association between audit fee premiums and type of material weakness remediated is strongest for ITMW linked to data processing integrity. Our findings, which are based on more robust contemporary research methods, underscore the importance of distinguishing not only between entity-level material weaknesses and ITMW but also between different types of ITMW as identified in prior data quality research.

Keywords: audit fees, data quality, internal controls, material weakness, remediation, SOX 404