Auditor realignment, voluntary SOX 404 adoption, and internal control material weakness remediation: Further evidence from U.S.-listed foreign firms

Abstract

This study examines whether auditor realignments and voluntary Sarbanes-Oxley (SOX) Section 404 adoption are associated with the remediation of internal control material weaknesses (ICMWs) in the case of U.S.-listed foreign companies. Furthermore, we investigate whether the results are driven by the home country’s legal systems. Using a sample of 266 U.S.-listed foreign firm-year observations reporting ICMWs, we found that firms engaging new auditors are more likely to remediate their ICMWs effectively in the subsequent year. Furthermore, we found that firms in the voluntary adoption period are less likely to solve internal control problems and that ICMW remediation significantly improved earnings quality. However, our results hold only for firms from common-law countries. This study provides evidence to academics that auditor realignment can serve as a functional change by which U.S.-listed foreign companies can remediate their ICMWs. Furthermore, this paper extends earlier cross-country research and suggests that country institutional differences affect the internal control reporting behavior of auditors and the effect of ICMW remediation on earnings quality.