SOX-Mandated Internal Control Deficiency Disclosure under Section 302 and Earnings Quality: Evidence from Cross-Listed Firms

Abstract

We examine the usefulness of SOX-mandated internal control deficiency (ICD) disclosure under Section 302 in assessing earnings quality for cross-listed firms relative to U.S. firms. Consistent with prior research, we find that U.S. firms' Section 302 ICD disclosure conveys useful information about earnings quality. However, cross-listed firms' Section 302 ICD disclosure is on average unrelated to earnings quality and significantly less informative about earnings quality than U.S. firms'. We provide evidence that the reduced usefulness of cross-listed firms' ICD disclosure is due to management's weaker incentive to detect and report existing ICDs. Specifically, the weaker association between the ICD disclosure and earnings quality for cross-listed firms relative to U.S. firms is primarily driven by cross-listed firms domiciled in weak investor protection countries. In addition, cross-listed firms' propensity to disclose ICDs declines with the degree of management's private control benefits and this effect is stronger for firms domiciled in weak investor protection countries.