Are Voluntary Internal Controls-Related Audit Report Disclosures Informative in IPOs?
60 Pages Posted: 15 Sep 2015
Date Written: September 14, 2015
Initial public offering (IPO) companies are exempt from Section 404 of the Sarbanes-Oxley Act of 2002, leaving investors to assess the quality of an IPO company’s internal controls, which affect the quality of management-provided financial information, without an opinion on internal controls effectiveness from management or the external auditor. When not engaged to opine on the effectiveness of internal controls, auditing standards permit auditors to voluntarily state that their opinion does not extend to internal control effectiveness. Given auditors’ limited ability to distinguish financial reporting quality in the unqualified audit report, the costly nature of audit report modifications, and auditors’ litigation risk concerns, these auditor voluntary internal controls-related disclosures are likely informative as to the quality of internal controls. Using a sample of IPOs completed on United States equity exchanges from 2005 through 2014, I predict and find that auditor voluntary internal controls-related disclosure is associated with a higher likelihood of post-IPO auditor-reported internal control deficiencies, higher IPO accounting and auditing expenses, lower post-IPO returns, and lower post-IPO earnings. These associations are robust to addressing the endogenous nature of the auditor’s disclosure decision. Overall, my results suggest that auditor voluntary disclosures are informative. This research should be of interest to investors, regulators tasked with reforming the audit reporting model, and legislators who recently passed Title I of the Jumpstart Our Business Startups Act that exempts qualifying IPO companies from Section 404(b) reporting requirements for up to five years.
Keywords: audit reports, voluntary disclosure, initial public offerings, internal controls
JEL Classification: M40, M41, M42, G32
Suggested Citation: Suggested Citation