Do Companies with Effective Internal Controls Over Financial Reporting Benefit from Sarbanes–Oxley Sections 302 and 404?

Posted: 2 Oct 2017 Last revised: 1 Apr 2018

See all articles by Parveen P. Gupta

Parveen P. Gupta

Lehigh University - Department of Accounting

Heibatollah Sami

Lehigh University

Haiyan Zhou

University of Texas - Pan American

Date Written: October 6, 2017

Abstract

Post-SOX (Sarbanes–Oxley Act) academic research on internal control focuses on the characteristics of publicly listed companies disclosing material control weaknesses or the consequences experienced by these companies. However, to date, limited research has empirically examined whether these new disclosures truly enhance “public interest” by promoting “equity” in the capital markets through enhanced information distribution. In this article, we empirically investigate the impact these disclosures have on information asymmetry and related market micro-structure. We hypothesize that both the management’s and the auditor’s reporting on internal control provide outside investors additional and higher quality information about a firm’s future prospects, thereby reducing the information asymmetry in capital markets. Such reduction in information asymmetry should be reflected in decreased bid-ask spreads and price volatility, as well as increased trading volume. Our cross-sectional analyses show that, subsequent to the management’s report on internal control per Section 302, the information environment improves for U.S. firms as manifested by decreased bid-ask spread and price volatility, and increased trading volume. However, we find no similar results subsequent to the auditors’ reporting on a company’s internal control over financial reporting. In our time-series intervention analyses, about 70% of sample firms have experienced significant and permanent reductions in their bid-ask spreads subsequent to the implementation of Section 302 of SOX, in contrast to only 30% of firms subsequent to the implementation of Section 404 of SOX. Our findings point to the public policy issue of whether financial reporting quality of public companies can be improved at a lower cost.

Keywords: Sarbanes-Oxley Act, SOX Section 303, SOX Section 404, Internal Controls, Information Environment, Bid-Ask Spreads

JEL Classification: M41, M42

Suggested Citation

Gupta, Parveen P. and Sami, Heibatollah and Zhou, Haiyan, Do Companies with Effective Internal Controls Over Financial Reporting Benefit from Sarbanes–Oxley Sections 302 and 404? (October 6, 2017). Journal of Accounting, Auditing and Finance, 2018, Vol. 33(2), 200-227, Available at SSRN: https://ssrn.com/abstract=3045882

Parveen P. Gupta (Contact Author)

Lehigh University - Department of Accounting ( email )

621 Taylor Street
RBC #37
Bethlehem, PA 18015
United States
610-758-3443 (Phone)
610-758-5992 (Fax)

HOME PAGE: http://www.lehigh.edu

Heibatollah Sami

Lehigh University ( email )

Bethlehem, PA 18015
United States
610-758-3407 (Phone)

Haiyan Zhou

University of Texas - Pan American ( email )

1201 West University Drive
Edinburg, TX 78539
United States
956-381-3334 (Phone)
956-381-2407 (Fax)

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