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Do Control Effectiveness Disclosures Require SOX 404(b) Internal Control Audits? A Natural Experiment with Small U.S. Public Companies

Journal of Accounting Research, Forthcoming

53 Pages Posted: 9 Jan 2010 Last revised: 13 May 2014

William R. Kinney, Jr.

University of Texas at Austin - Department of Accounting

Marcy L. Shepardson

Indiana University - Kelley School of Business - Department of Accounting

Date Written: December 6, 2010

Abstract

We use incremental and joint implementation of multiple SOX-based control effectiveness disclosure and audit mandates to assess relative performance of alternatives for small U.S. public companies. Using data from several low and high effort management disclosure and audit regimes implemented from 2003-2008, we find substantial and statistically significant increases in material weakness disclosure rates for small firms undergoing initial SOX 404(b) internal control audits, but find quantitatively and statistically similar increases for initial management reports of small firms exempt from such audits. As to audit cost, fees more than double for initial 404(b) audits in 2004 and remain high, while 404(b)-exempt firms’ fees grow about ten percent annually. Our results support the view that, for small firms, management internal control reports and traditional financial audits may be a cost effective disclosure alternative to full application of SOX 404(b). Also, our results suggest that, even without management reports on internal control, analysis of the cause of known accounting mistakes may yield substantial material weakness disclosures.

Keywords: Sarbanes-Oxley Act, Internal Control, Material Weakness, Auditing, Disclosure regulation

JEL Classification: C91, M44, M45, M41

Suggested Citation

Kinney, Jr., William R. and Shepardson, Marcy L., Do Control Effectiveness Disclosures Require SOX 404(b) Internal Control Audits? A Natural Experiment with Small U.S. Public Companies (December 6, 2010). Journal of Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1533527

William Kinney (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States
512-471-3632 (Phone)
512-471-3904 (Fax)

Marcy L. Shepardson

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

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