Was Dodd‐Frank justified in granting internal control audit exemption to small firms?

Abstract

PurposeThe purpose of this paper is to estimate the cost of the internal control audit for small firms and assess whether the costs are scalable or, alternatively, whether they are higher in relation to firm size for small firms than for larger firms.Design/methodology/approachThe method estimates the Section 404 audit fee premium for companies that became accelerated filers for the first time in 2006 and 2007. The authors use the estimated audit fee premium as a proxy for the premium that non‐accelerated filers would have to pay if they were required to obtain an internal control audit.FindingsThe main finding shows that the Section 404(b) estimated cost of the internal control audit divided by assets are significantly higher for non‐accelerated filers and first‐time filers than for those of larger firms.Research limitations/implicationsOne limitation of the study is that, while it shows that the costs of the Section 404 audit are not scalable to firm size, it does not prove that the costs of the audit exceed the benefits for non‐accelerated filers.Practical implicationsThe finding that the costs are proportionately higher for small firms provides some evidence supporting the decision to permanently exempt non‐accelerated filers from Section 404(b).Originality/valueThe results show that smaller firms pay proportionately more for the Section 404 internal control audit than larger firms. This suggests that the revised AS no. 5 did not succeed in making the internal control audit completely scalable to firm size.