Audit Quality and Internal Control Weakness: Evidence from SOX 404 Disclosures

Abstract

In this paper we seek to determine whether high audit quality leads to a lower incidence of internal control weakness; and, whether there is an association between audit quality and remediation of internal control weakness. Using a comprehensive sample of 22,616 firm-year observations spanning the period 2004-2009, we show that Big 4 audits, auditor office size, industry specialization of auditors and auditor tenure have a significant negative relationship with the incidence of internal control problems. We also examine the effectiveness of audit quality on different types of internal control weakness and our findings show that our measures of audit quality help reduce the probability of different types of internal control weakness. We also show that ICW remediation is negatively and significantly associated with all four measures of audit quality, suggesting that firms audited by high quality auditors are associated with faster remediation of internal control weakness. Our results are robust to alternative definitions of audit quality measures, propensity score matching method and endogenous effects. Taken together, we provide compelling evidence that our audit quality proxies are associated with a lower incidence of internal control weakness.