The Benefits of Auditors’ Attestation on Internal Control: Evidence from Annual Report Misstatements

• In Event: SESSION 6A: Internal Control Issues

Abstract

Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX 404(b)) mandates auditors attest to the effectiveness of client’s internal control over financial reporting (ICFR) for accelerated filers. The high costs associated with the SOX 404(b) triggers heated debate over the merit of this legislature. We examine the effects of auditor attestation on ICFR on audit quality. We find SOX 404(b) compliance significantly reduces the probability of future annual report restatements, and significantly increases the likelihood that auditors detect and correct misstatements. These findings cannot be explained by pre-existing differences between accelerated and non-accelerated filers prior to SOX 404(b) implementation. After controlling for public information about future restatement probability, material weakness disclosures under SOX 302 fail to provide incremental explanatory power for future restatements, whereas material weakness disclosures under SOX 404(b) predict future annual report restatements, implying the SOX 404(b) disclosures are more useful to investors for assessing financial report quality.

Author

• Yuping Zhao, University of Houston-Houston