How Understandable Are SOX 404 Auditors’ Reports to Investors?

• In Event: Understanding Investor Behavior

Abstract

This study experimentally examines a random sample of 48 SOX 404 reports issued between 2004 and 2009 to determine their understandability as measured by readers’ rating of overall weakness severity and coding errors related to internal control weaknesses reported therein. This is contrasted with readability as measured by metrics such as the FOG index. The results indicate that perceived severity of internal control weaknesses is associated with audit experience and with the number of non-IT weaknesses reported, despite the fact that both IT and non-IT weaknesses are reported in the sample of reports used in this study and that participants with and without audit experience code the same number of weaknesses. We find that readers’ understanding of non-IT weaknesses is positively associated with their audit experience, albeit the significance of the association depends on report readability. Audit experience is also associated with significantly fewer false negative ITW coding errors in hard to read reports. Understanding is evident even when readability measured by the FOG index is low, casting some doubt on the sufficiency of readability as a measure of informativeness. Investors do not seem to increase their level of effort to understand reports as readability declines, whereas novice auditors increase their level of effort to counter declines in readability and thereby reduce their coding errors.

Authors

• J Efrim Boritz, University of Waterloo

• Beverly Louise Hayes, University of Waterloo

• Lev Timoshenko, University of Waterloo