The Failure to Remediate Previously-Disclosed Material Weaknesses in Internal Controls

Posted: 15 Jan 2009 Last revised: 11 Jul 2012

See all articles by Jacqueline S. Hammersley

Jacqueline S. Hammersley

University of Georgia - J.M. Tull School of Accounting

Linda A. Myers

University of Tennessee, Haslam College of Business, Accounting and Information Management

Jian Zhou

University of Hawaii at Manoa

Date Written: July 11, 2012

Abstract

In this paper, we study a sample of companies that fail to remediate previously-disclosed material weaknesses (MWs) in their internal control systems and thus disclose the same MWs in two consecutive annual reports. Their failure to remediate is surprising given that regulators, credit rating agencies, and academics contend that the remediation of MWs is important. We form a control sample of companies that initially disclosed MWs in their internal control systems but subsequently remediated these weaknesses, and investigate the characteristics of the remediated and unremediated MWs, the characteristics of remediating versus non-remediating companies, and the consequences to non-remediating companies.

Regarding the characteristics of companies failing to remediate, we find that companies are less likely to remediate previously-disclosed MWs when the weaknesses are more pervasive (i.e., when they are described as at the entity level, when there are more individual weaknesses) and when their operations are more complex (i.e., they have more segments and have foreign operations). In addition, companies with smaller audit committees are less likely to remediate.

Regarding the consequences, we find that companies failing to remediate MWs experience larger increases in audit fees and a higher likelihood of auditor resignation as the number of MWs increases. We also find that non-remediating companies are more likely to receive modified audit opinions and going concern opinions. Finally, we find that companies failing to remediate are more likely to miss filing deadlines and experience increased cost of debt capital (i.e., they receive poorer credit ratings when entity level MWs are present and are charged higher interest rates).

Keywords: material weaknesses, internal controls, remediation, Sarbanes-Oxley Act

JEL Classification: M41, M49, G18, G34, G38, K22

Suggested Citation

Hammersley, Jacqueline S. and Myers, Linda A. and Zhou, Jian, The Failure to Remediate Previously-Disclosed Material Weaknesses in Internal Controls (July 11, 2012). Auditing: A Journal of Practice & Theory, Vol. 31, No. 2, 2012. Available at SSRN: https://ssrn.com/abstract=1327470 or http://dx.doi.org/10.2139/ssrn.1327470

Jacqueline S. Hammersley (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

Linda A. Myers

University of Tennessee, Haslam College of Business, Accounting and Information Management ( email )

Knoxville, TN
United States

Jian Zhou

University of Hawaii at Manoa ( email )

Honolulu, HI 96822
United States

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