The Effect of Voluntary Internal Control Audits on the Cost of Capital
54 Pages Posted: 4 Jan 2011 Last revised: 14 Nov 2013
Date Written: June 1, 2013
In this paper, we investigate whether companies that voluntarily have their internal controls audited by an external auditor enjoy a lower cost of capital. Using a sample of companies that voluntarily have their internal controls audited by an external auditor and a control group of companies that report on the strength of internal controls but do not have management’s internal control assertions audited, we first model the determinants of voluntary internal control audits. We find that companies issuing equity or debt and those with stronger monitoring mechanisms (i.e., Big 4 auditors and higher institutional ownership) are more likely to voluntarily purchase internal control audits. Next, we test whether companies that voluntarily purchase internal control audits enjoy a lower cost of capital relative to companies that do not purchase internal control audits and find that the cost of equity and the cost of debt capital are significantly lower for those companies choosing to have their internal controls audited. Our findings are important because they demonstrate an important benefit that small companies can derive from purchasing internal control audits.
Keywords: Sarbanes-Oxley Act Section 404, internal control, cost of capital, voluntary audit, voluntary disclosure, non-accelerated filers
JEL Classification: M41
Suggested Citation: Suggested Citation