Sarbanes‐Oxley section 404 compliance

Abstract

PurposeThe purpose of this study is to investigate the compliance of US‐traded foreign firms with Sarbanes‐Oxley section 404 (SOX 404) by examining recent changes in their material internal control weakness (ICW) disclosures. This study also seeks to explore as a result of compliance, whether large firms can improve their internal controls than small and mid‐sized businesses (SMBs) can.Design/methodology/approachThis study uses a logit regression model to test the data collected from Compustat and AuditAnalytics databases.FindingsBoth US firms and US‐traded foreign firms from developed countries experienced a significant descending trend of material ICW disclosures from 2004 to 2006. US SMBs, like large US companies, improved internal controls.Research limitations/implicationsPrior studies asserted that the environment of corporate governance is more favourable for firms in developed countries. This study documents that US‐traded foreign firms from developed countries adjust to SOX 404 more quickly than do those from developing countries, resulting in fewer material ICW disclosures.Originality/valueAlthough SOX 404 imposes vast costs on US‐traded foreign firms, investors can benefit from the improved internal control over financial reporting, as the Securities and Exchange Commission asserts. This paper contributes to the literature that US‐traded foreign firms from developed countries adjust to SOX 404 more quickly than those from developing countries. Although the significant fixed cost of implementing SOX 404 impacts SMBs disproportionately, US SMBs, like larger firms, still show an improvement in their internal control systems over time.