Audit Quality and Internal Control Weakness: Evidence from SOX 404 Disclosures

61 Pages Posted: 5 Jan 2012 Last revised: 18 Jan 2012

See all articles by Yangyang Chen

Yangyang Chen

City University of Hong Kong (CityU) - Department of Accountancy

Ferdinand A. Gul

Monash University Sunway Campus

Cameron Truong

Monash University; Financial Research Network (FIRN)

Madhu Veeraraghavan

T.A. PAI Management Institute, Finance Area; T A Pai Management Institute, Manipal

Date Written: January 4, 2012

Abstract

In this paper we seek to determine whether high audit quality leads to a lower incidence of internal control weakness; and, whether there is an association between audit quality and remediation of internal control weakness. Using a comprehensive sample of 22,616 firm-year observations spanning the period 2004-2009, we show that Big 4 audits, auditor office size, industry specialization of auditors and auditor tenure have a significant negative relationship with the incidence of internal control problems. We also examine the effectiveness of audit quality on different types of internal control weakness and our findings show that our measures of audit quality help reduce the probability of different types of internal control weakness.

We also show that ICW remediation is negatively and significantly associated with all four measures of audit quality, suggesting that firms audited by high quality auditors are associated with faster remediation of internal control weakness. Our results are robust to alternative definitions of audit quality measures, propensity score matching method and endogenous effects. Taken together, we provide compelling evidence that our audit quality proxies are associated with a lower incidence of internal control weakness.

Keywords: internal control weakness, audit quality, big 4, office size, industry specialization, auditor tenure

JEL Classification: G10, G18

Suggested Citation

Chen, Yangyang and Gul, Ferdinand A. and Truong, Cameron and Veeraraghavan, Madhu, Audit Quality and Internal Control Weakness: Evidence from SOX 404 Disclosures (January 4, 2012). Available at SSRN: https://ssrn.com/abstract=1979323 or http://dx.doi.org/10.2139/ssrn.1979323

Yangyang Chen

City University of Hong Kong (CityU) - Department of Accountancy ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
China

Ferdinand A. Gul

Monash University Sunway Campus ( email )

Jalan Lagoon Selatan
Selangor Darul Ehsan
Bandar Sunway, 46150
Malaysia

Cameron Truong

Monash University ( email )

23 Innovation Walk
Wellington Road
Clayton, Victoria 3800
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Madhu Veeraraghavan (Contact Author)

T.A. PAI Management Institute, Finance Area ( email )

Bangalore
Manipal, Karnataka 576104
India
+91-820-2701030 (Phone)

T A Pai Management Institute, Manipal ( email )

TAPMI Canpus
Manipal
Manipal, Manipal 576104
India
+91-820-2701020 (Phone)

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