Does SOX 404 Have Teeth? Consequences of the Failure to Report Existing Internal Control Weaknesses

47 Pages Posted: 8 Oct 2014

See all articles by Sarah C. Rice

Sarah C. Rice

Texas A&M University - Mays Business School

David P. Weber

University of Connecticut - Department of Accounting

Biyu Wu

University of Nebraska at Lincoln - School of Accountancy

Date Written: September 1, 2014

Abstract

We examine various penalties that could serve as enforcement mechanisms for SOX 404. We focus on firms with restatements, some of which had previously reported their control weaknesses as required and some of which acknowledged them only after announcing their restatement. We find no evidence that penalties are more likely for firms, managers, or auditors that fail to report existing control weaknesses. Instead, class action lawsuits, management turnover, and auditor turnover are all more likely in the wake of a restatement when control weaknesses had previously been reported. We find similar, though weaker, evidence for SEC sanctions. These results are consistent with disclosure of control weaknesses making it difficult for management to plausibly claim later that they were unaware of the underlying conditions that led to restatements. The results also suggest that the public and private enforcement mechanisms surrounding SOX 404 are unlikely to provide strong incentives for compliance and offer a potential explanation for why most restatements are issued by firms that previously claimed to have effective internal controls.

Keywords: Sarbanes-Oxley Act, internal controls, enforcement, restatements

JEL Classification: M41, K22, K4

Suggested Citation

Rice, Sarah C. and Weber, David P. and Wu, Biyu, Does SOX 404 Have Teeth? Consequences of the Failure to Report Existing Internal Control Weaknesses (September 1, 2014). Accounting Review, Forthcoming, Mays Business School Research Paper No. 2506896, Available at SSRN: https://ssrn.com/abstract=2506896

Sarah C. Rice

Texas A&M University - Mays Business School ( email )

Wehner 401Q, MS 4353
College Station, TX 77843-4218
United States

David P. Weber (Contact Author)

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

Biyu Wu

University of Nebraska at Lincoln - School of Accountancy ( email )

Lincoln, NE 68588
United States

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