“Surprise” material weakness disclosures: Effects on audit fees and audit report lags

Abstract

Prior research shows that many of the companies that disclose material weaknesses in internal control (MWs) do not disclose such weaknesses in earlier quarterly 10-Q filings for the same year—i.e., the year-end MW disclosures are “surprise” disclosures. I first show, using data from 2009 to 2019, that such surprise MWs continue to be the majority of MW disclosures as late as 2019. I find that accelerated filer companies with surprise MWs pay lower fees compared to companies with no-surprise MWs; however, this finding does not hold for non-accelerated filers. I also find that there are no significant differences in the audit report lag of surprise and no-surprise MW disclosers. Thus, the lower audit fee paid by surprise MW disclosure companies may offer a possible explanation for the widespread prevalence of surprise MW disclosures. The results also highlight the importance of the external auditor in public disclosures of MWs. The findings have public policy relevance given the ongoing efforts to expand the set of companies that would be exempt from the auditor attestation of internal controls.