Market reactions to the disclosure of internal control weaknesses and to the characteristics of those weaknesses under section 302 of the Sarbanes Oxley Act of 2002

Abstract

We examine the stock price reaction to management’s disclosure of internal control weaknesses under §302 of the Sarbanes Oxley Act and to the characteristics of these weaknesses, controlling for other material announcements in the event window. We find that some characteristics of the weaknesses—their severity, management’s conclusion regarding the effectiveness of the controls, their auditability, and the vagueness of the disclosures—are informative. We also find that the information content of internal control weakness disclosures depends on the severity of the internal control weakness. Moreover, in a sub-sample uncontaminated by other announcements in the event window, we find negative price reactions to the disclosure of internal control weaknesses and material weaknesses.