Internal Control Weakness Disclosure and Firm Investment

Abstract

I use Sarbanes–Oxley Act Section 404 auditor opinions on the effectiveness of internal control over financial reporting to examine whether firm investment level is associated with the disclosure of internal control weaknesses. I find that firms that receive adverse auditor internal control opinions have significantly lower investment than firms that receive clean opinions. I also find that these firms’ investment decreases after the weakness revelation and then increases after the weakness remediation. I further find that these firms’ reduction in investment is driven by the decrease in the relatively risky components of investment (i.e., acquisitions, research and development expenses). These results suggest that internal control evaluation and disclosure have significant influence on operating decisions within the firms.