Are Remediated Material Weaknesses Truly Remediated?

• In Event: Internal Controls

Abstract

Prior literature finds the market rewards companies that signal the remediation of previously disclosed internal control weaknesses. However, the SEC has recently questioned the accuracy of management’s internal control disclosures. In this study, we examine the accuracy of, and users’ responses to, reports of material weakness remediation. We find that companies reporting remediation are still significantly more likely, on average, to restate their financial statements compared to companies with no material weaknesses in the current or prior year. The likelihood of restatement is even greater when companies report remediation of multiple material weaknesses in a single year. Furthermore, we find that investors are generally unable to distinguish “false” remediators from “true” remediators; however, higher audit fees paid by “false” remediators indicate auditors are aware of continuing control deficiencies. Overall, our results suggest that, although companies may report remediation to the investing public, ex-post restatements suggest that financial reporting quality for some companies remains low.

Authors

• Brant E. Christensen, University of Missouri-Columbia

• Stevanie S. Neuman, University of Missouri-Columbia

• Sarah Rice, Texas A&M University