Regulatory Enforcement, Internal Control Disclosures and Audit Quality

40 Pages Posted: 9 Feb 2022

See all articles by Kyungha Lee

Kyungha Lee

Rutgers Business School at Newark & New Brunswick

Rahul Menon

Purdue University

Date Written: February 2, 2022

Abstract

This paper studies how regulatory enforcement and penalties affect audit transparency and audit quality. In our model, the auditor first tests a firm's internal control over financial reporting before auditing the financial report, and is required to provide an opinion on both the firm's internal control and financial report. In this setting, we examine how different types of enforcement affect the auditor's effort choices, reporting strategy, and ultimately audit quality. We find that regulatory penalties can have a non-monotonic effect on audit quality, and that policies aimed at increasing audit transparency can inadvertently decrease audit quality. We also show the importance of balancing randomized and targeted inspections of audits.

Keywords: Internal Controls, Audit transparency, Enforcement, SOX 404

JEL Classification: M41,M42

Suggested Citation

Lee, Kyungha (Kari) and Menon, Rahul, Regulatory Enforcement, Internal Control Disclosures and Audit Quality (February 2, 2022). Available at SSRN: https://ssrn.com/abstract=4025251 or http://dx.doi.org/10.2139/ssrn.4025251

Kyungha (Kari) Lee (Contact Author)

Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

Rahul Menon

Purdue University ( email )

610 Purdue Mall
West Lafayette, IN 47906
United States

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