Early Warnings of Internal Control Problems: Additional Evidence

Abstract

SUMMARY:Hermanson and Ye (2009; hereafter, HY) find that in the initial year of SOX Section 404 implementation, only 27 percent of accelerated filer firms with an adverse Section 404(b) report had disclosed such material weaknesses (MWs) in internal control in Section 302 certifications in previous quarters of the same fiscal year. We extend HY by examining (1) a more recent time period (using data from fiscal years 2007 and 2008), and (2) both accelerated and non-accelerated filers. We find that the proportion of accelerated filers (with adverse Section 404 reports) that have early warnings (in Section 302 certifications in previous quarters of the same fiscal year) is less than 50 percent even in the fourth and fifth years of Section 404 reporting. We also find that, after controlling for other factors, non-accelerated filers were more likely to have early warnings than accelerated filers in 2008; however, the difference is not significant in 2007. Early warning is more likely for firms with (1) a higher number of MWs, (2) a new CFO, (3) more audit committee members, and (4) more frequent audit committee meetings.