Do Management Internal Control Certifications Increase the Likelihood of Restatement-Related Litigation?
48 Pages Posted: 2 Nov 2012 Last revised: 26 Apr 2013
Date Written: April 24, 2013
Although the Sarbanes-Oxley Act of 2002 imposes internal control disclosure and certification requirements on management, regulators are concerned that companies are not disclosing material internal control weaknesses on a timely basis. This study investigates whether litigation risk could act as a mechanism to incentivize timely material weakness disclosure. Examining material weakness and restatement disclosures from 2003 – 2011, we find that restatement-related litigation is significantly greater for firms with material weakness disclosures regardless of when the material weakness was disclosed (i.e., during the misstated time period or following the restatement announcement). In fact, we find that over 75 percent of lawsuits allege that management falsely certified internal controls regardless of whether the material weakness was disclosed during or after the misstated time period. While we do not find evidence that internal control-related arguments are associated with the resolution of litigation, our results generally indicate that SOX-mandated internal control certifications are increasing litigation costs without providing management with an incentive to disclose material weaknesses on a timely basis.
Keywords: internal control weaknesses, class-action litigation, financial statement restatements, disclosure timeliness
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