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Investor reactions to disclosures of material internal control weaknesses

Kim Ittonen
Department of Accounting and Finance, University of Vaasa, Vaasa, Finland
Abstract
Purpose The purpose of this paper is to examine investor reactions to material internal control weakness disclosures. In particular, the abnormal returns, the change in volatility, and the change in systematic risk are analyzed around auditors material weakness reports. Design/methodology/approach The sample consists of 342 rms with initial Sarbanes-Oxley Act, Section 404 weakness disclosures issued between 2005 and 2007. The paper uses three measures for investor reactions: abnormal returns and the change in volatility and systematic risk. The hypotheses of the paper are investigated using univariate analysis. Findings The initial results imply surprisingly that the material weakness disclosure is good news to investors. However, after controlling for the preceding managements internal control disclosure, the results show that the abnormal reaction is positive only when the audit report is consistent with the preceding management report. In addition, the results show a signicant change in volatility after the auditors weakness disclosure. Research limitations/implications These results imply that the investor reactions to auditors material weakness disclosures depend on the content of the preceding report issued by management: there is a positive reaction if management has identied and reported the existing material weaknesses before the auditor, and a negative reaction when management has failed to identify or report the material weaknesses before the auditor. Originality/value The ndings of this paper emphasize that the value of the information contained in the auditors material internal control weakness disclosures vary signicantly depending on management disclosures. Keywords Internal control, Disclosure, Investors Paper type Research paper

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Received 1 July 2009 Revised 14 December 2009 Accepted 15 December 2009

1. Introduction The implementation of the Sarbanes-Oxley Act (SOX, 2002) Sections 302 and 404 changed the requirements for making public disclosures regarding internal controls. Section 302 of the Act requires that the chief executive ofcer and the chief nancial ofcer in the periodic statutory nancial reports evaluate the effectiveness of the internal controls and disclose any weaknesses in internal controls. Section 404 of the Act requires that public rm annual lings (10-K) contain the managements assessment of the design and the effectiveness of the rms internal controls. Moreover, it also demands the auditor to provide a separate opinion on managements assessment and the auditors evaluation of the internal controls. Research on both Sections 302 and 404 disclosures
The author gratefully acknowledges the comments of the two referees, MAJ Editors, ha maa. Jyrki Niskanen, Stefan Sundgren, and Sami Va

Managerial Auditing Journal Vol. 25 No. 3, 2010 pp. 259-268 q Emerald Group Publishing Limited 0268-6902 DOI 10.1108/02686901011026350

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show that internal control weakness disclosures are associated with rms that are smaller, nancially weaker, rapidly growing, more complex, have less expertise on the audit committee, less independent auditors, and recent auditor changes (Ashbaugh-Skaife et al., 2007; Doyle et al., 2007b; Zhang et al., 2007). As expected, weaknesses in internal controls are also related to decreased nancial statement quality (Doyle et al., 2007a; Ashbaugh-Skaife et al., 2008). In existing literature, Beneish et al. (2008) nd a negative investor reaction to Section 302 disclosures but no reaction to Section 404 internal control weaknesses. Hammersley et al. (2008) study the reactions to Section 302 disclosures and nd that the information content of the internal control weakness disclosures depend on the severity of the weakness. In this paper, the abnormal returns, the change in volatility, and the change in systematic risk around the announcement of the auditors internal control weakness disclosures are examined. The contribution of this paper is threefold. First, it provides further evidence on the abnormal returns around Section 404 internal control weaknesses. Second, the volatility and systematic risk effects of internal control weakness disclosures are analyzed. Third, as suggested in previous literature two event dates are studied, the customary 10-K ling date (Jones, 1996; Beneish et al., 2008; Hammersley et al., 2008) and the date of the actual event, i.e. the audit report date (Carter and Soo, 1999; Knechel et al., 2007). The initial ndings suggest that the weakness disclosure is good news to the investors. Abnormal returns are positive and partly signicant around the audit report date as well as the 10-K date. Following Beneish et al. (2008) the sample is split based on the preceding managements internal control assessment. The results show that the abnormal reaction is positive and signicant when the audit report is consistent with the management report, and negative when the audit report is conicting with the management report. Beneish et al. (2008) report the similar (but insignicant) directions for abnormal returns for the Bad, Bad and Good, Bad rms. Finally, this paper reports a signicant increase in volatility around the audit report date and a signicant decrease around the 10-K date. The remainder of this paper is organized as follows. The hypotheses are developed in Section 2, Section 3 reports the sample and the methodology, Section 4 contains results, and Section 5 concludes the paper. 2. Background and hypotheses Research on both Sections 302 and 404 disclosures show that internal control weaknesses are associated with rms that are smaller, nancially weaker, rapidly growing, more complex, and have ongoing restructuring (Doyle et al., 2007b; Ashbaugh-Skaife et al., 2007). Zhang et al. (2007) nd rms with less nancial and non-accounting nancial expertise on their audit committees, less independent auditors, and recent auditor changes are more likely to disclose internal control weaknesses. Furthermore, Doyle et al. (2007a) and Ashbaugh-Skaife et al. (2008) nd that internal control weaknesses are associated with lower quality accruals. Schneider and Church (2008) nd that weaknesses in internal controls reduce the lenders condence on nancial statements. In general, weaknesses in internal controls can affect the quality of nancial statements by either allowing more intentional earnings management or unintentional errors. The evidence (Ashbaugh-Skaife et al., 2008) suggests, however, that weaknesses are more likely to lead to unintentional errors.

Previous studies suggest that there is a negative abnormal reaction to the announcement of managements Section 302 internal control weaknesses (Beneish et al., 2008; Hammersley et al., 2008). Beneish et al. (2008) report that the auditor quality and client size attenuates the reaction to Section 302 disclosures, and Hammersley et al. (2008) nd that the reaction depends on the characteristics of the weakness. The empirical evidence suggests that auditors Section 404 internal control weakness disclosures are not associated with abnormal returns around the announcement (Ogneva et al., 2007; Beneish et al., 2008). Beneish et al. (2008) conclude that the information environment of rms that are required to report under Section 404 is richer and this attenuates the surprise or that Section 404 reports may reect a low materiality threshold for disclosure. In an additional analysis, Beneish et al. (2008) study the cost of capital effects of internal control weakness disclosures. They report that for Section 302 reports increased the cost of capital, whereas Section 404 reports do not. Ashbaugh-Skaife et al. (2009) in their working paper nd a signicant negative market reaction to Section 404 reports, and also their cross-sectional test indicates that the systematic risks are higher for rms disclosing internal control weaknesses. Similarly, Schneider and Church (2008) nd that the bank loan ofcers assessments are negatively affected by disclosed internal control weaknesses. In contrast, Ogneva et al. (2007) nd that internal control weaknesses are not associated with higher cost of equity. Most previous studies, use abnormal stock returns to measure the investor reactions to qualied audit report announcements. However, as Fargher and Wilkins (1998) point out, stock prices reect both the expected size of the future cash ows and the expected risk of the future cash ows. The internal control weakness disclosure has the potential to add uncertainty to the stock markets, i.e. increase the risk of future cash ows, since the internal control weaknesses may have implications on nancial information quality, management reliability, or management competence. As a result, the weaknesses may complicate the estimation of future cash ows of the rm and this will increase the risk of the rm, i.e. the chance that the future cash ows will be different from what is currently expected. By recognizing that audit reports may affect the risk of the rm, it is important also to examine the change in risk. In this study, the change in volatility and change in systematic risk are used to measure whether an adjustment in the risk levels has occurred as a result of the auditors internal control weakness disclosure. Consequently, this study tests the following hypotheses: H1a. H1b. H1c. Auditors internal control weakness disclosures are associated with negative abnormal returns. Auditors internal control weakness disclosures are associated with an increase in volatility. Auditors internal control weakness disclosures are associated with an increase in systematic risk.

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3. Sample and methodology The sample of this study includes Russell 3000 index constituents with auditors internal control weakness disclosures. Since the Section 404 of SOX (2002) became effective for scal years ending on or after November 15, 2004, Section 404 reports from January 2005 to December 2007 are included in the sample[1]. Following prior studies, two restrictions are made in dening the nal sample. First, only rst time auditors

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internal control weakness reports are included in the sample (Jones, 1996) and second all nancial institutions (Standard Industry Classication (SIC) codes 6000-6999) are excluded from the sample (Luo, 2008). After applying these lters the sample consists of 342 rms. These rms have a rst time internal control weakness report. This sample includes 59 cases where the management has previously indicated effective internal controls in the Section 302 disclosure. The rms with Section 404 reports are classied by year and industry in Table I. Table I clearly shows that there was a peak in the number of Section 404 reports during the year 2005. The grouping by industry reveals that the number of weaknesses is signicantly higher in two industries: manufacturing and services. However, an examination of the proportions of weaknesses relative to industry representations reveals that in the services industry the proportion of rms with weaknesses is signicantly higher than in the population of the Russell 3000 index. The stock price data used in the analyses are from Thomson Financial Datastream. Following previous studies (Beneish et al., 2008; Hammersley et al., 2008) the abnormal returns are calculated for a short event period. This study uses standardized market-model adjusted returns[2] over a two-day (0; 1), three-day (21; 1), and four-day (0; 3) period surrounding two alternative event days: the audit report date and the 10-K ling date. The event dates are selected based on suggestions in previous literature. First, the traditional event day is the 10-K ling date ( Jones, 1996; Beneish et al., 2008), which is the date when the rm publicly announces the audit report. However, the audit report is appended to the annual 10-K ling and therefore there is a signicant amount of noise in the returns around that date. Second, the audit report date (i.e. the date typed by the auditor on the audit report) is considered to be the rst possible day when the auditors written assessment of the rms internal controls is known by anyone else than the auditor. Thus, it is considered to be the rst possible day of trade using this information. The use of this event date is suggested and supported by Carter et al. (1999) and Knechel et al. (2007) who investigate market reactions to 8-K lings. Carter et al. (1999) conclude that using the 8-K report stamp date instead of the date of the event could be one reason why previous studies have failed to detect a signicant reaction to the 8-K report lings. But, because the rms do not publicly announce the news at the date of the event, one would have to assume that any observed abnormal returns in that event period is a result of informed trading.
Sample rms (%) 5.26 29.82 8.77 16.67 39.47 Firms in Russell 3000 (%) 6.92 45.49 11.82 12.82 22.92

SIC code 0-1999 2000-3999 4000-4999 5000-5999 7000-8999 Table I. Number of rms by SIC codes and years

Industry description Agriculture, mining and construction Manufacturing Transportation, communications, electric, gas, and sanitary services Wholesale and retail trade Services

2005 17 87 26 53 114

2006 1 13 4 4 20

2007 2

Notes: The table presents the number of rms by SIC codes divided across year of rst-time internal control deciency audit report. The sample consists of 342 rms, nancial institutions (SIC codes between 6000 and 6900) are excluded from the sample

In this study, it is suggested that if economically signicant benets are attainable the insiders initiate trades when the content of the auditors report is revealed. In practice, the audit report date is typically also the date when the audit report is delivered to the ofcials of the rm. However, while this study does not specically identify insider trading, further research is needed to examine whether the insiders are trading on the audit report information prior to its public announcement. To empirically test whether the volatility[3] and systematic risk[4] of the stock changed after internal control weakness disclosures, the standard deviation and beta are estimated for each rm before and after the internal control weakness report date. The pre-audit report estimation period is [2 130, 2 10] and the post-audit report estimation period is [10; 130], with the event date day [0] being alternatively the audit report date or the 10-K report ling date. The change in standard deviation and beta for each rm is the difference between the pre- and post-period estimations. To control for the inuence of outliers the standardized abnormal returns (SARs), as well as the measures for volatility and systematic risk have been winsorized at the top and bottom 2.5 percent. 4. Results Table II reports some summary statistics for 310 (out of 342) sample rms with data available on Thomson Financial Worldscope. The table contains the statistics of the total sample and two sub-samples; rms with the preceding Section 302 also indicating internal control weaknesses, and the rms with Section 302 indicating that internal controls are effective. The statistics show that the rms with conicting Sections 404 and 302 are larger, more leveraged, have higher return on assets and they have a higher percentage of management ownership. Table III provides the main ndings of this study. First, in Panel A, around the audit report date, the abnormal returns in (0; 1) is positive and signicant (at the 5 percent level). Second, around the 10-K ling date, the abnormal returns are positive in all three periods. These ndings indicate that the Section 404 weakness disclosure is good news to the investors. Next, Panels B and C of Table III provide a closer examination of two sub-samples: (1) the group with consistent; and (2) the group with conicting Sections 404 and 302 reports. The fundamental difference between these groups is that in the group with the consistent reports the management disclosures on internal control weaknesses attenuate the surprise of the subsequent auditors weakness disclosures. On the contrary, in the group with the conicting internal control disclosures, the negative impact of the auditors weakness disclosures are strengthened by the inability or unwillingness of the management to disclose these internal control weaknesses. In Panel B, around the audit report date, the abnormal returns are positive and signicant in all periods. The result is the same around the 10-K ling. Again, this indicates that when the auditor conrms the observations of the management the reaction is positive and signicant (at the 1 percent level). One explanation for the positive reaction is that the managements Section 302 weakness disclosures preceding the auditors reports increase the apprehensions that the auditors reports may contain more severe ndings

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Size Total sample Mean 6.861 Median 6.616 Maximum 10.339 Minimum 4.241 SD 1.519 Skewness 0.456 Kurtosis 2.561 n 310 Consistent SOX 404 and 302 Mean 6.754 Median 6.559 Maximum 10.339 Minimum 4.241 SD 1.474 Skewness 0.479 Kurtosis 2.667 n 263 Conicting SOX 404 and 302 Mean 7.462 Median 7.322 Maximum 10.339 Minimum 4.241 SD 1.642 Skewness 0.209 Kurtosis 2.055 n 47

Leverage 23.197 18.971 87.087 0.000 23.031 1.008 3.395 310 22.618 17.508 87.087 0.000 23.064 1.059 3.512 263 26.439 25.553 87.087 0.000 22.817 0.754 2.920 47

ManOwn 22.846 18.801 75.645 0.329 18.983 0.995 3.504 310 21.992 18.074 75.645 0.329 18.147 0.917 3.341 263 27.629 22.353 75.645 0.329 22.745 1.010 3.026 47

Z-score 2 0.187 0.111 1.253 2 4.931 1.190 2 2.314 8.907 310 2 0.207 0.102 1.253 2 4.931 1.190 2 2.261 8.777 263 2 0.075 0.150 1.253 2 4.931 1.196 2 2.647 9.906 47

ROA 2.850 3.523 22.350 2 25.711 9.085 2 0.931 5.095 310 2.455 3.437 22.350 2 25.711 9.332 2 1.018 4.891 263 5.062 4.045 22.350 2 10.041 7.250 0.661 3.816 47

PB 3.075 2.299 14.077 0.437 2.568 2.583 10.459 310 3.163 2.333 14.077 0.437 2.691 2.514 9.771 263 2.579 2.140 9.056 0.752 1.663 1.814 6.803 47

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Table II. Descriptive statistics

Notes: The table reports the descriptive statistics of the sample. The variables are dened as follows: size, the natural log of total assets; leverage, total debt to total assets; ManOwn, the closely held shares percent; Z-score, the one-year lagged Altmans Z-score adjusted by Grice and Dugan (2003); ROA, the return on assets; and PB, the price to book ratio

than the managements reports disclosed. Therefore, the fact that the auditor comes to the same conclusion than the management, is good news. In Panel C, the mean abnormal returns around the audit report date are negative and signicant in period (0; 3). Around the 10-K date, the abnormal returns are negative and signicant in all three periods. The ndings in Panel C conrm that the information content of Section 404 reports is different depending on the managements Section 302 report, both around the audit report date as well as the 10-K ling date. The negative reaction to the auditors Section 404 disclosure, when it conicts with the Section 302 report, is likely to be a combined effect of the internal control weakness itself and the managements unwillingness to report or incapability to detect such weaknesses. Table III also provides empirical evidence of the change in volatility and systematic risk after the internal control weakness disclosure. In Table III Panels A-C, the volatility (STDAR) increases signicantly (at the 1 percent level) after the date of the Section 404 internal control weakness report. The change in systematic risk (BETAAR) is also positive, but statistically insignicant. In contrast, measured after the 10-K ling date

CSARAR [0; 1] STDAR 0.007 * * * (8.685) 0.002 0.096 2 0.023 0.015 1.526 7.087 342 0.025 (0.971) 0.003 1.333 2 1.578 0.493 2 0.139 3.285 342 0.043 (1.466) 0.013 1.333 2 1.578 0.506 2 0.210 3.263 286 2 0.063 (1.177) 2 0.063 1.165 2 1.044 0.414 0.193 3.470 56 2 0.549 * * * (3.366) 2 0.521 3.364 2 2.532 1.221 0.765 4.229 56 2 0.406 * (1.889) 2 0.329 2.733 2 5.304 1.607 2 0.254 3.265 56 0.297 * * * (3.821) 0.193 3.364 2 2.532 1.313 0.247 2.959 286 2 0.515 * * (2.318) 2 0.502 3.708 2 3.220 1.662 0.218 2.602 56 0.310 * * * (3.096) 0.269 5.527 2 4.253 1.694 0.116 3.224 286 0.381 * * * (4.347) 0.339 3.731 2 3.220 1.482 0.079 2.979 286 2 0.001 * * * (4.031) 0.000 0.031 2 0.027 0.007 2 0.086 5.783 286 2 0.001 (1.084) 2 0.001 0.014 2 0.014 0.005 2 0.041 3.925 56 0.007 * * * (7.750) 0.002 0.096 2 0.023 0.016 1.544 7.196 286 0.007 * * * (4.031) 0.001 0.049 2 0.011 0.013 1.233 4.321 56 0.158 * * (2.192) 0.030 3.364 2 2.532 1.334 0.305 2.968 342 0.193 * * (2.102) 0.178 5.527 2 5.304 1.699 0.074 3.289 342 0.234 * * * (2.802) 0.244 3.731 2 3.220 1.547 0.031 2.903 342 2 0.001 * * * (2.650) 2 0.001 0.031 2 0.027 0.007 2 0.093 5.918 342 2 0.001 (0.977) 2 0.002 1.181 2 1.017 0.361 0.223 3.552 342 2 0.002 (1.177) 2 0.007 1.181 2 1.017 0.365 0.198 3.441 286 0.005 (0.109) 0.000 0.995 2 0.785 0.340 0.386 4.216 56 BETAAR STD10-K BETA10-K 0.118 (1.481) 0.177 3.376 2 3.130 1.471 2 0.009 2.885 342 0.188 * * (2.263) 0.248 3.376 2 3.130 1.401 2 0.049 3.050 286 2 0.238 (1.014) 2 0.530 3.376 2 3.130 1.758 0.325 2.436 56

Audit report date CSARAR [0; 3] CSARAR [21; 1] CSAR10-K [0; 1]

10-K ling date CSAR10-K [0; 3] CSAR10-K [21; 1]

Panel A. Total sample Mean 0.136 * * 0.138 (t-stat) (2.064) (1.565) Median 0.093 0.086 Maximum 2.778 5.769 Minimum 2 2.349 2 3.779 SD 1.216 1.628 Skewness 0.121 0.133 Kurtosis 2.714 2.973 n 342 342 Panel B. Consistent SOX 404 and 302 * * * Mean 0.183 0.249 * * * (t-stat) (2.627) (2.618) Median 0.141 0.215 Maximum 2.778 5.769 Minimum 2 2.349 2 3.750 SD 1.179 1.605 Skewness 0.077 0.118 Kurtosis 2.815 3.107 n 286 286 Panel C. Conicting SOX 404 and 302 Mean 2 0.107 2 0.428 * (t-stat) (0.581) (1.952) Median 2 0.369 2 0.420 Maximum 2.778 3.771 Minimum 2 2.349 2 3.779 SD 1.374 1.641 Skewness 0.413 0.307 Kurtosis 2.485 2.564 n 56 56

Notes: *, * * and * * * denotes signicance at the 0.1, 0.05 and 0.01 levels, respectively. The table reports the descriptive statistics of the sample. All variables are winsorized at the top and bottom 2.5 percent. (i) The dependent variables are CSARAR and CSAR10-K, the cumulative SARs around the audit report date and the 10-K ling date. (ii) The independent variables are dened as follows: ManOwn, is the closely held shares percent; size, the natural log of total assets; leverage, total debt to total assets; and Z-score, the one-year lagged Altmans Z-score adjusted by Grice and Dugan (2003). The table presents the empirical results on the abnormal returns, the change in volatility, and the change in systematic risk around the SOX 404 disclosure. CSARi is the cumulative SAR measured in two to four days periods around the audit report date (AR) and the 10-K ling date (10-K). STDi is the change in the standard deviation of the stock returns after the SOX 404 announcement. BETAi is the change in capital asset pricing model (CAPM) beta after the SOX 404 announcement

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Table III. Results

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the volatility (STD10-K) reduces signicantly in both Panels A and C, in Panel B the negative change is insignicant. The systematic risk (BETA10-K) reduces as well, but the change is again statistically insignicant. The positive change in volatility after the audit report date indicates that the Section 404 disclosure increases the spread of future cash ow estimations, i.e. uncertainty, among the investors. The reduction in volatility after the 10-K report is likely to be a combined result of all items disclosed in the 10-K. After the annual report ling the quantity and quality of information available for all investors is higher and therefore the future cash ow estimations among the investors are more constant, and thus the volatility is lower. Overall, these results suggest that the Section 404 report on internal control weaknesses contains relevant information for the investors. However, the information content is signicantly affected by the content of the preceding Section 302 management disclosure on internal control weaknesses. 5. Conclusions This paper examines the markets reaction to auditors internal control weakness disclosures under Section 404. Market reactions are measured by the short-window abnormal returns, the change in volatility and the change in systematic risk around the event dates. The empirical ndings suggest that there is a signicant market reaction to the internal control weaknesses disclosure. First, signicant positive abnormal returns are documented in the sample around both event dates: the audit report date and the 10-K ling date. This nding suggests that the Section 404 weakness disclosure is good news, i.e. that investors revise upwards their expectations on future cash ows. However, when the sample is split by the content of the preceding management Section 302 disclosure, the results indicate that for rms with consistent Sections 404 and 302 disclosures, the abnormal returns are signicantly positive, and for rms with conicting Sections 404 and 302 disclosures, the abnormal returns are signicantly negative. The auditors internal control weakness disclosures conrming the disclosures of the management may be good news to investors if the preceding managements internal control disclosures have caused expectations of more severe disclosures in the audit reports. On the contrary, in the case of conicting management and audit disclosures, i.e. when the management has been unable to detect or unwilling to disclose the internal control weaknesses, the auditors weakness disclosures will come as a negative surprise. Inconsistent Sections 404 and 302 reports cast signicant doubt on the quality and reliability of nancial information prepared by the management, and in addition, the trustworthiness and competence of the management. Reecting the ndings of this study to Beneish et al. (2008), it can be noted that the signs of the abnormal reactions are identical (positive for the Bad, Bad rms, and negative for the Good, Bad rms), however, in this study the results are statistically signicant. This difference may be explained by different sample periods. Second, the evidence indicates a signicant increase in the volatility of the stock returns after the date of the audit report, and a decrease in volatility after the 10-K report. After the audit report date the spread of rm value estimates between the investors increase most likely because the costs and the consequences of the internal control weakness disclosure are difcult to estimate. The decrease in the volatility after the 10-K report is likely to be a combined result of all items disclosed in the 10-K.

The annual ling increases the quantity and the quality of information available for all investors, and therefore the estimations of rm value among the investors are more constant. Overall, this paper provides evidence that the information content of the Section 404 is dependent on the preceding management disclosure on internal control weaknesses.
Notes 1. November 15, 2004 for accelerated lers, and July 15, 2005 for rms under the accelerated lers threshold. 2. First, the daily market-model abnormal return is estimated using an estimation period of 200-days for the parameters ai and bi : ARit Rit 2 ai bi Rmt , where: ARit is the abnormal return for rm i at time t, Rit is the return for rm i at time t, and Rmt is the return of the market (Russell 3000) at time t. Next, to obtain the SARs the estimated ARit is divided by the estimation period standard deviation of abnormal returns. The SAR has the advantage of taking into account the heteroskedasticity in returns: SARit ARit ; ^ SARit

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where SARit is the abnormal return for rm i at time t, ARit is the return for rm i at time t, and ^ ARit is the standard deviation of estimation period abnormal returns for rm i at time t. S 3. The standard deviation of the pre- and post-event stock returns is estimated as follows: s Pn  2 t 1 Rit 2 Rit s n21  it is the mean of values Rit, n is the sample size. where Rit is the return of stock i in period t, R 4. The systematic risk, the CAPM beta, is estimated as follows:

bi

sim s2 m

where, sim is the covariance between stock is return and the market return (Russell 3000 index) and s2 m is the variance of the market return (Russell 3000 index). References Ashbaugh-Skaife, H., Collins, D. and Kinney, W. (2007), The discovery and reporting of internal control deciencies prior to SOX-mandated audits, Journal of Accounting and Economics, Vol. 44 Nos 1/2, pp. 166-92. Ashbaugh-Skaife, H., Collins, D., Kinney, W. and LaFond, R. (2008), The effect of SOX internal control deciencies and their remediation on accrual quality, The Accounting Review, Vol. 83 No. 1, pp. 217-50. Ashbaugh-Skaife, H., Collins, D., Kinney, W. and LaFond, R. (2009), The effect of SOX internal control deciencies on rm risk and cost of equity, Journal of Accounting and Economics, Vol. 47 No. 1, pp. 1-43. Beneish, M., Billings, M. and Hodder, L. (2008), Internal control weaknesses and information uncertainty, The Accounting Review, Vol. 83 No. 3, pp. 665-703. Carter, M. and Soo, B. (1999), The relevance of 8-K reports, Journal of Accounting Research, Vol. 37 No. 1, pp. 119-32.

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Doyle, J., Ge, W. and McVay, S. (2007a), Accruals quality and internal control over nancial reporting, The Accounting Review, Vol. 82 No. 5, pp. 1141-70. Doyle, J., Ge, W. and McVay, S. (2007b), Determinants of weaknesses in internal control over nancial reporting, Journal of Accounting and Economics, Vol. 44 Nos 1/2, pp. 193-223. Fargher, N. and Wilkins, M. (1998), Evidence on risk changes around audit qualication and qualication withdrawal announcements, Journal of Business Finance & Accounting, Vol. 25 Nos 7/8, pp. 829-47. Grice, J. and Dugan, M. (2003), Re-estimation of the Zmijewski and Ohlson bankruptcy prediction models, Advances in Accounting, Vol. 20, pp. 77-93. Hammersley, J., Myers, L. and Shakespeare, C. (2008), Market reactions to the disclosure of internal control weaknesses and to the characteristics of those weaknesses under Section 302 of the Sarbanes Oxley Act of 2002, Review of Accounting Studies, Vol. 13 No. 1, pp. 141-65. Jones, F. (1996), The information content of the auditors going concern evaluation, Journal of Accounting & Public Policy, Vol. 15 No. 1, pp. 1-27. Knechel, R., Naiker, V. and Pacheco, G. (2007), Does industry specialization matter? Evidence from market reaction to auditor switches, Auditing: A Journal of Practice & Theory, Vol. 26 No. 1, pp. 19-45. Luo, M. (2008), Unusual operating cash ows and stock returns, Journal of Accounting & Public Policy, Vol. 27 No. 5, pp. 420-9. Ogneva, M., Subramanyam, K. and Raghunandan, K. (2007), Internal control weakness and cost of equity: evidence from SOX Section 404 disclosures, The Accounting Review, Vol. 82 No. 5, pp. 1255-97. Schneider, A. and Church, B. (2008), The effect of auditors internal control opinions on loan decisions, Journal of Accounting & Public Policy, Vol. 27 No. 1, pp. 1-18. SOX (2002), The Sarbanes-Oxley Act of 2002, United States House of Representatives, Public Law 107-204 [H.R. 3763], US Government Printing Ofce, Washington, DC. Zhang, Y., Zhou, J. and Zhou, N. (2007), Audit committee quality, auditor independence, and internal control weaknesses, Journal of Accounting & Public Policy, Vol. 26 No. 3, pp. 300-27. About the author Kim Ittonen, PhD, is an Assistant Professor of Accounting and Finance at the University of Vaasa, Finland. He received his doctoral degree from the University of Vaasa. Kim Ittonen can be contacted at: kit@uwasa.

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