Economic Determinants and Consequences of the Proactive Disclosure of Internal Control Weaknesses and Remediation Progress in IPO

Auditing: A Journal of Practice & Theory (Forthcoming)

Posted: 11 May 2017 Last revised: 10 Aug 2017

See all articles by Sudipta Basu

Sudipta Basu

Temple University - Department of Accounting

Jagan Krishnan

Temple University - Department of Accounting

Jong Eun Lee

Sungkyunkwan University

Yinqi Zhang

American University

Date Written: July 1, 2017

Abstract

This study investigates (a) why some IPO firms proactively disclose internal control weaknesses (ICWs) and remediation progress in their prospectuses before going public, despite being exempt from the requirements of Sections 302 and 404 of the Sarbanes-Oxley Act at the time of IPO, and (b) the association of such disclosures with IPO underpricing (i.e., the first-day return). We find that IPO firms that proactively disclose ICWs and remediation progress have higher litigation risk, are audited by industry specialist auditors, and are more likely to have audit committees prior to the IPO, compared with firms that do not disclose such information, after controlling for the ex-ante probability of having ICWs. IPO underpricing is lower for firms that disclose ICWs and remediation progress, consistent with the conjecture that the disclosure of ICWs and remediation progress signals extensive premarket due diligence, thus reducing the information asymmetry between informed and uninformed investors.

Keywords: Internal Control Weaknesses; SOX 302; SOX 404; IPO Underpricing

JEL Classification: G24; K22; M13; M41; M42; M49

Suggested Citation

Basu, Sudipta and Krishnan, Jagan and Lee, Jong Eun and Zhang, Yinqi, Economic Determinants and Consequences of the Proactive Disclosure of Internal Control Weaknesses and Remediation Progress in IPO (July 1, 2017). Auditing: A Journal of Practice & Theory (Forthcoming). Available at SSRN: https://ssrn.com/abstract=2966375 or http://dx.doi.org/10.2139/ssrn.2966375

Sudipta Basu

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States
215.204.0489 (Phone)
215.204.5587 (Fax)

Jagan Krishnan (Contact Author)

Temple University - Department of Accounting ( email )

Fox School of Business & Management
1801 Liacorous Walk
Philadelphia, PA 19122
United States
215-204-8126 (Phone)
215-204-5587 (Fax)

Jong Eun Lee

Sungkyunkwan University ( email )

25-2 Sungkyunkwan-ro
Jongno-gu
Seoul, 110-745
Korea, Republic of (South Korea)
82-2-760-0441 (Phone)
82-2760-0440 (Fax)

Yinqi Zhang

American University ( email )

4400 Massachusetts Ave NW
Washington, DC 20016
United States

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