Economic Determinants and Consequences of Voluntary Disclosure of Internal Control Effectiveness: Evidence from Initial Public Offerings

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This study investigates the incentives and market reactions to IPO firms’ preemptive disclosure of internal control weaknesses in their prospectuses, in spite of exemptions from the requirements of Sections 302 and 402 of the Sarbanes-Oxley Act before going public. We find IPO firms with greater litigation risk are more likely to disclose internal control weaknesses after controlling for the probability of having internal control weaknesses. Voluntary disclosures of internal control problems and the related remediation procedures are associated with less IPO underpricing, consistent with the proposition (e.g., Rock 1986; Beatty and Ritter 1986) that more IPO-related disclosures may reduce the information asymmetry between informed and uninformed investors.