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This paper aims to investigate whether the Section 404 of Sarbanes–Oxley Act (SOX 404) changed the way banks use accounting information to price corporate loans.
Abstract
Purpose
This paper aims to investigate whether the Section 404 of Sarbanes–Oxley Act (SOX 404) changed the way banks use accounting information to price corporate loans.
Design/methodology/approach
The study uses a sample of 1,173 US-listed firms that issued syndicated loans both before and after their compliance with SOX 404 to analyze the changes in loan spread’s sensitivity to some key accounting metrics such as ROA, interest coverage, leverage and net worth.
Findings
The study finds that the interest spread’s sensitivity to key accounting metrics, most noticeably for ROA, declined following the borrower’s compliance with the requirements of SOX 404. The decline was not explainable by borrowers that disclosed internal control weaknesses but concentrated among borrowers suspected of real earnings management (REM).
Originality/value
By examining the effects of SOX 404 on banks’ pricing process, this study augments the literature on SOX’s economic consequences. The findings suggest that lenders perceive little new information from SOX 404 disclosures of internal control deficiencies and are cautious about the accounting information provided by REM borrowers. It also extends the research on the use of accounting information in debt contracting. By examining loan interest’s sensitivity to accounting metrics, it broadens the concept of debt contracting value of accounting information to include accounting’s usefulness for assessing credit risk at loan inception.
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The purpose of this study is to investigate the compliance of US‐traded foreign firms with Sarbanes‐Oxley section 404 (SOX 404) by examining recent changes in their material…
Abstract
Purpose
The purpose of this study is to investigate the compliance of US‐traded foreign firms with Sarbanes‐Oxley section 404 (SOX 404) by examining recent changes in their material internal control weakness (ICW) disclosures. This study also seeks to explore as a result of compliance, whether large firms can improve their internal controls than small and mid‐sized businesses (SMBs) can.
Design/methodology/approach
This study uses a logit regression model to test the data collected from Compustat and AuditAnalytics databases.
Findings
Both US firms and US‐traded foreign firms from developed countries experienced a significant descending trend of material ICW disclosures from 2004 to 2006. US SMBs, like large US companies, improved internal controls.
Research limitations/implications
Prior studies asserted that the environment of corporate governance is more favourable for firms in developed countries. This study documents that US‐traded foreign firms from developed countries adjust to SOX 404 more quickly than do those from developing countries, resulting in fewer material ICW disclosures.
Originality/value
Although SOX 404 imposes vast costs on US‐traded foreign firms, investors can benefit from the improved internal control over financial reporting, as the Securities and Exchange Commission asserts. This paper contributes to the literature that US‐traded foreign firms from developed countries adjust to SOX 404 more quickly than those from developing countries. Although the significant fixed cost of implementing SOX 404 impacts SMBs disproportionately, US SMBs, like larger firms, still show an improvement in their internal control systems over time.
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Kam C. Chan, Picheng Lee and Gim S. Seow
The purpose of this paper is to investigate the rationale for the failure of management and auditors to identify material internal control weaknesses (ICWs) in their initial…
Abstract
Purpose
The purpose of this paper is to investigate the rationale for the failure of management and auditors to identify material internal control weaknesses (ICWs) in their initial Sarbanes‐Oxley Act of 2002 (SOX) 404 reviews, resulting in subsequent restatement of their opinions.
Design/methodology/approach
The paper focuses on the factors associated with the failure of management and auditor to identify material internal controls weaknesses in their initial SOX 404 reports. Logistic regression is run on a sample of 56 firms that reported material internal controls weaknesses in their amended internal control reports and a control group of 344 firms that reported material internal controls weaknesses (i.e. ineffective internal controls) in their initial internal control reports for 2004.
Findings
The results show that firm size, the use of a Big 4 auditor, the ratio of non‐audit to total fees, and the need for accounting restatements are positively associated with the probability to file an amended internal control report. The number of ICWs and the number of audit committee meetings are negatively associated with the probability to file an amended internal control report.
Practical implications
The paper's findings suggest that regulators and corporate boards should consider providing more guidelines on audit committee practices in addition to the audit committee structure. For example, more guidance by the board is needed to ensure that the audit committee is active in overseeing the company's auditor–client relationship and its internal audit function.
Originality/value
Empirical findings on factors associated with the failure of management and auditor to identify material ICWs in their SOX 404 review can contribute to an understanding of factors affecting the efficiency of the SOX 404 review by attributing such failure to either inherent factors such as operational complexity and industry membership or to managerial choices in auditor‐client relationship and corporate governance issues. An understanding of these factors can help companies and the Public Company Accounting Oversight Board and the Securities and Exchange Commission in their efforts to improve the effectiveness and the efficiency of the current SOX 404 process.
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The purpose of this paper is to empirically examine the corporate governance and financial characteristics of firms under the new Sarbanes‐Oxley (SOX) accounting regime.
Abstract
Purpose
The purpose of this paper is to empirically examine the corporate governance and financial characteristics of firms under the new Sarbanes‐Oxley (SOX) accounting regime.
Design/methodology/approach
The paper first compares a comprehensive set of characteristics across firms in two states of SOX Section 404 status–Compliance and Violation. It then tests for determinants of SOX compliance in a logistic regression setting.
Findings
Several differences between compliance groups in terms of equity ownership, board structure, and executive compensation schemes are reported. However, it appears that firms found to be in violation of SOX are not systematically worse when it comes to common measures of corporate governance. The financial structure and soundness of the groups of firms are very similar. The strongest determinant of Section 404 compliance is firm size.
Originality/value
This result supported anecdotal evidence that compliance with SOX is achieved primarily by firms that can afford it. Further, the paper highlights an important policy issue: Is SOX really differentiating firms in terms of corporate governance or in terms of size?
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Benjamin W. Hoffman and Albert L. Nagy
This paper aims to investigate whether the expected implementation of Section 404(b) of the Sarbanes-Oxley Act (SOX 404(b)) (the integrated audit requirement) caused auditors to…
Abstract
Purpose
This paper aims to investigate whether the expected implementation of Section 404(b) of the Sarbanes-Oxley Act (SOX 404(b)) (the integrated audit requirement) caused auditors to discount their audit fees for non-accelerated filers in anticipation of expected increased future economic rents (DeAngelo, 1981) from those clients.
Design/methodology/approach
This paper predicts that auditors charged their non-accelerated filer clients lower audit fees during the years 2005-2007 (in anticipation of increased expected future economic rents from the implementation of the SOX 404(b) requirement) compared with the years 2010-2012 (when it had been determined that non-accelerated filers were permanently exempt from complying with SOX 404(b)). The authors use ordinary least squares regression analysis to examine whether audit fees increased significantly for non-accelerated filers after the permanent exemption announcement.
Findings
The results show a significant positive association between the exemption announcement and audit fees, supporting the theory that auditors discounted their audit fees for non-accelerated filers in the pre-exemption announcement period. This finding is robust when sensitivity tests are used.
Practical implications
The findings of audit fee discounting literature related to the post-SOX period are mixed. This study adds to this stream of literature by supporting the notion that audit fee discounting is being practiced post-SOX and is a potential unintended consequence of SOX 404 and the exemption. Thus, investors will be interested in the results of this paper when making their investment decisions with regard to non-accelerated filers.
Social implications
The results of this paper show that, even in the post-SOX environment, auditors will employ the use of audit fee discounting if a change in regulation incentivizes it. This commentary on the present state of the audit pricing market should be of interest to audit pricing policymakers.
Originality/value
This paper is one of the first to study audit fee discounting outside the realm of initial audit engagements.
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The purpose of this paper is to analyze the efficiency of the internal control reporting (ICR) requirements imposed by Sections 302 and 404 of the Sarbanes‐Oxley Act of 2002 (SOX…
Abstract
Purpose
The purpose of this paper is to analyze the efficiency of the internal control reporting (ICR) requirements imposed by Sections 302 and 404 of the Sarbanes‐Oxley Act of 2002 (SOX). The lessons learned are then applied to the current financial crisis.
Design/methodology/approach
The Coase Theorem is applied to the events leading up to the collapse of Enron and the enactment of SOX. The paper then analyzes the efficacy of the various examples of ICR regulation, both pre‐ and post‐SOX, noting the ways in which they effectively mitigate transaction costs and the ways in which they over‐regulate.
Findings
US investors continue to invest in foreign markets despite the fact that those markets maintain less demanding ICR requirements than those required by Section 404. Moreover, investors do not respond negatively to Section 404 disclosures. The research demonstrates that Section 404 does not provide useful information in the minds of investors. Considering Section 404's ineffectiveness and the burdensome costs it imposes on reporting companies, it is clear that Section 404 is an example of over‐regulation and should be repealed.
Practical implications
The transaction costs that caused the collapse of Enron and the enactment of SOX bear strong similarities to those causing the more recent subprime mortgage crisis. The lessons learned from the enactment of SOX Section 404 are directly applicable to the current financial crisis and should be noted moving forward.
Originality/value
By utilizing a law and economics perspective, the paper more clearly demonstrates how Section 404 is an example of over‐regulation and draws links to the current economic crisis.
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Benjamin P. Foster, William Ornstein and Trimbak Shastri
Section 404 of the Sarbanes‐Oxley Act (SOX) of 2002 required companies to report on the effectiveness of their internal controls over financial reporting. Auditors also must…
Abstract
Purpose
Section 404 of the Sarbanes‐Oxley Act (SOX) of 2002 required companies to report on the effectiveness of their internal controls over financial reporting. Auditors also must attest to, and report on, the assessment of the effectiveness of internal control over financial reporting made by the management of the company being audited. The purpose of this paper is to provide analyses of audit fee costs and material weaknesses reported for companies of different sizes after the effective date of Section 404 and suggest approaches to reduce SOX 404 compliance costs.
Design/methodology/approach
Quantitative analysis and deductive reasoning are used to evaluate audit costs associated with Section 404.
Findings
Audit fees have been increased substantially, particularly during the first year a company complied with Section 404, and have not been dropped substantially after the first year of compliance. Companies with sales of less than $1 billion reported significantly more material weaknesses than larger companies.
Originality/value
This paper documents audit costs after the SOX Section 404 effective date, the typical types of material weaknesses reported, the proportion of companies of different sizes reporting material weaknesses, and describes approaches to reduce compliance costs.
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Keryn Chalmers, David Hay and Hichem Khlif
In 2001, the US moved to regulate internal control reporting by management and auditors. While some jurisdictions have followed the lead of the US, many others have not. An…
Abstract
In 2001, the US moved to regulate internal control reporting by management and auditors. While some jurisdictions have followed the lead of the US, many others have not. An important question, therefore, is the relevance of internal control to stakeholders. The more specific issue of the benefits of US-style regulation of internal control reporting is also topical. We review studies on the determinants of internal control quality and its economic consequences for stakeholders including investors, creditors, managers, auditors and financial analysts. We extend previous reviews by focusing on US studies published since 2013 as well as all non-US studies investigating IC quality including countries regulating IC disclosure as well as unregulated settings and both developed and developing economies. In doing so, we identify research questions where evidence remains mixed and new directions in which there are research opportunities.
Three main insights arise from our analysis. First, evidence on the economic consequences of internal control quality suggests that the quality of internal control can have a significant effect on decision making by users of financial information. Second, the results of research on the empirical association between ownership structure, certain board characteristics and internal control quality is generally mixed. Empirical evidence concerning the association between audit committee characteristics and internal control quality generally supports a positive and significant association. Finally, while studies in non-US jurisdictions are increasing, opportunities remain to explore the determinants and consequences of internal control in other jurisdictions. Our review provides evidence for policy makers of whether there are benefits from requiring management and auditors to report on internal control over financial reporting.
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Benjamin W. Hoffman and Albert L. Nagy
This paper aims to investigate whether the Sarbanes-Oxley Act: Section 404(b) exemption caused an increase in auditor changes due to changes in expectations for both auditors and…
Abstract
Purpose
This paper aims to investigate whether the Sarbanes-Oxley Act: Section 404(b) exemption caused an increase in auditor changes due to changes in expectations for both auditors and their clients.
Design/methodology/approach
This paper predicts that this exemption caused a significant amount of auditor changes post-exemption, due to a change in expected future economic rents (audit scope demands) for auditors (clients). Logistic regression analysis is used to examine whether auditor changes increased for non-accelerated filers (public companies with less than $75 million in public float), who were affected by this exemption, compared to auditor changes for accelerated filers (public companies with greater than $75 million in public float), who were not affected by this exemption.
Findings
The results show a significant positive association between the exemption and auditor dismissals for non-accelerated filers compared to that of accelerated filers. This finding is robust when sensitivity tests are used.
Practical implications
Prior literature finds that an increase in auditor changes can have various positive and negative effects on the affected companies. Thus, investors will be interested in the results of this paper when making their investment decisions with regard to non-accelerated filers.
Social implications
The results of this paper will aid policymakers as they consider the pros and cons of this exemption, as it pertains to the affected companies.
Originality/value
This paper is the first to study the effects of this exemption on auditor turnover for the affected companies.
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Stuart Michelson, Jud Stryker and Betty Thorne
The purpose of this paper is to explore the impact of the Sarbanes‐Oxley (SOX) Act of 2002 on small corporations when compared to large firms and to investigate differences…
Abstract
Purpose
The purpose of this paper is to explore the impact of the Sarbanes‐Oxley (SOX) Act of 2002 on small corporations when compared to large firms and to investigate differences perceived by small and large firms with respect to costs and internal controls.
Design/methodology/approach
A questionnaire containing 20 questions (five demographic and 15 addressing issues related to SOX implementation) was mailed to 5,479 board members, chief executive officers (CEOs) and chief financial officers (CFOs) of 676 separate firms with 117 completed surveys returned.
Findings
The results of the study show significant differences in the responses between small and large firms concerning: the overall impact of SOX on the firm; the amount of time dedicated to SOX; the role of the external auditor; the firm's implementation stage; the most significant challenges due to SOX implementation; the corporate governance reforms instituted; and changes in board compensation.
Research limitations/implications
The basic limitation of this paper is the low‐response rate (slightly more than 2 per cent) which is not surprising since CEOs, CFOs, and board of directors have a low tendency to respond to surveys.
Originality/value
The findings of this paper suggest that: recent actions taken by the Securities and Exchange Commission (SEC) are appropriate in providing much needed relief for smaller public firms; and lend support for further actions of assistance by the SEC. This paper is of value to academicians, practitioners and to an international audience engaged in the harmonization of accounting standards.
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