The Valuation Effect and Motivations of Voluntary Compliance with Auditor's Attestation Under Sarbanes-Oxley Act Section 404 (B)

Abstract

On November 4th 2009, non-accelerated filers have been permanently exempted from compliance with SOX Section 404(b) (404 (b)) which called for independent auditor attestation. While compliance with 404(b) had never been mandatory, a number of companies voluntarily comply with it despite the compliance costs and risks associated with ICW discovery. This study develops a signaling model to explain what motivates non-accelerated filers to voluntarily comply with 404(b); examines the valuation effect of the permanent exemption; and examines the determinants of the valuation effects in terms of signaling effect, quality of firms’ internal control over financial reporting (ICOFR) and liquidity enhancement. We find evidence that auditor attestation serves as a signaling mechanism to certify firm quality of ICOFR; companies voluntarily submit to auditor’s attestation to signal their superior quality of ICOFR. This signal is credible because it’s costly, in terms of additional compliance costs and the risks of discovery of material weaknesses of internal control; companies that comply with 404(b) have lower bid-ask spread, less return volatility, followed by more analysts, more likely to be audited by Big4 auditing firms, higher liquidity, more effective internal control, and less restatements; market response to the announcement of permanent exemption is significantly negative and it’s more negative for non-compliance firms; cross-sectional and logistic regression reveals that voluntary compliance with 404(b) improves the quality of ICOFR, liquidity and signals firm superior quality.