Internal Control Deficiency Disclosures among Chinese Reverse Merger Firms

• In Event: Internal Controls

Abstract

In recent years, financial reporting problems among Chinese reverse merger firms(CRMs), listed on U.S. exchanges, have attracted unfavorable attention from regulators,investors, and the business press. Under the SOX Act of 2002, managers’ Section 302 assessments of internal control over financial reporting are intended to provide investors with early warning about the likelihood of current and future non-GAAP financial reporting problems. We investigate whether managers’ propensity to issue unfavorable SOX 302 reports when internal control problems exist, and whether financial reporting problem occurrence following “clean” SOX 302 reports, differ for CRM firms compared to several control samples. We find that managers of CRMs have equal or greater propensity to issue adverse SOX 302 reports when serious internal control problems exist in the current quarter. However, when managers of CRMs issue “clean” SOX 302 reports, the CRMs are more likely than are control firms to experience subsequent misstatements of financial reports.

Authors

• Juan Mao, The University of Texas at San Antonio

• Michael Ettredge, The University of Kansas