Determinants and Consequences of Noncompliance with the 2013 COSO Framework

Abstract

The Securities and Exchange Commission (SEC) requires firms to use a “suitable framework” as a basis for evaluating the effectiveness of internal control over financial reporting. The COSO 1992 framework was the most commonly used suitable framework until it was superseded by the COSO 2013 framework. Because strict compliance with the updated framework was not enforced by regulatory authorities, a non-trivial amount of firms did not comply in a timely fashion. We investigate determinants and consequences of noncompliance with the COSO 2013 framework following the supersession of the COSO 1992 framework. We find that noncompliance is positively associated with proxies for resource constraints, financial distress, and a weak internal control environment, and negatively associated with auditor industry specialization, board size, and audit committee accounting expertise. Further tests suggest that following supersession of the 1992 framework investors view noncompliance firms’ quarterly earnings surprises less credibly and that noncompliance increases regulatory scrutiny. Finally, we find some evidence that accounting conservatism increases after the supersession of the 1992 framework for compliant firms relative to noncompliant firms, suggesting noncompliance can delay the potential benefits of implementing the updated framework.

Keywords: COSO2013 internal control framework; noncompliance; internal controls; investor perceptions; regulatory scrutiny; accounting conservatism

JEL Classification: M41; M42