Material Weakness Remediation and Earnings Quality: A Detailed Examination by Type of Control Deficiency
39 Pages Posted: 6 Dec 2009 Last revised: 5 Dec 2012
Date Written: June 9, 2011
This paper investigates remediation of Sarbanes-Oxley Section 404 material weaknesses (MWs). Prior research examines full remediation of all MWs or broad categories thereof. We build on these studies by investigating remediation of specific types of MW, thus measuring progress in improving controls made by companies that have not fully remediated all problems. Specifically, we investigate whether specific MW types differ in remediation likelihood and in the association of remediation with earnings quality. Results show that remediation rates of specific MW types vary, and that remediation of specific types is differentially associated with resource availability and corporate governance quality. We also find that remediation of some MW types is significantly associated with changes in abnormal accruals (e.g., entity-level problems in reconciliation and information technology, along with account-specific problems in revenue and tax). Finally, results show that problems remaining unremediated for two years are significantly associated with increased abnormal accruals, regardless of type.
Keywords: Sarbanes-Oxley Section 404, Internal control, Material weakness, Remediation
JEL Classification: M41
Suggested Citation: Suggested Citation