Costs and Benefits of Internal Control Audits: Evidence from M&A Transactions

48 Pages Posted: 26 Apr 2017 Last revised: 26 Jul 2018

See all articles by Todd D. Kravet

Todd D. Kravet

University of Connecticut - Department of Accounting

Sarah E. McVay

University of Washington

David P. Weber

University of Connecticut - Department of Accounting

Date Written: July 9, 2018

Abstract

To inform the debate on the merits of internal control audits, we examine managers’ decisions to temporarily exempt newly acquired businesses from Section 404 of the Sarbanes-Oxley Act. We provide evidence that managers are more likely to elect the exemption when expected compliance costs are higher, such as when acquisitions are larger and occur later in the year. We find only modest evidence that managers use the exemption to avoid scrutiny of value-destroying deals. Exemption use, however, is associated with negative post-acquisition outcomes, including lower return-on-assets and higher likelihoods of goodwill impairments and financial statement restatements. These results are consistent with compliance providing benefits by facilitating timely identification and correction of control problems in the newly acquired business. Finally, we document negative abnormal stock returns at the time exemption use is announced and over the subsequent three years, suggesting that investors view exemption use negatively and that their initial price reactions are incomplete.

Keywords: Internal Controls, Sarbanes-Oxley, Mergers and Acquisitions

JEL Classification: G30, G34, K22, M4

Suggested Citation

Kravet, Todd D. and McVay, Sarah E. and Weber, David P., Costs and Benefits of Internal Control Audits: Evidence from M&A Transactions (July 9, 2018). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2958318 or http://dx.doi.org/10.2139/ssrn.2958318

Todd D. Kravet

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

Sarah E. McVay (Contact Author)

University of Washington ( email )

Box 353200
Seattle, WA 98195-3200
United States

David P. Weber

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

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