The Endogenity of Material Weakness in Internal Controls—Implications on Auditors Dismissal Decisions

• In Event: Public Interest II

Abstract

This paper investigates the dynamic nature of material weakness in internal controls by examining the determinants of material weakness and its effects on auditor dismissal. We first document the endogenity of material weakness for firms reporting material weakness and subsequently dismissing their external auditors. We examine firms’ dismissal as a function of material weakness, firm characteristics and corporate governance characteristics. We find that size, firm age, complexity, restructure, and corporate governance are determinants of material weakness in internal control. The evidence suggests that material weakness firms are more likely to dismiss their auditors if they have entity-level material weakness, are smaller in size, distressed, have a long auditor-client relationship, are charged high audit fees, and have weak corporate governance. Overall, our study contributes to the current debate on the effectiveness of corporate governance, and the benefits of Sarbanes-Oxley Act (SOX). The evidence provided in this study should be of interest to regulators, audit firm managers, and the public.

Authors

• Mai Dao, University of Toledo

• Hassan HassabElnaby, University of Toledo

• Amal A Said, University of Toledo