Internal Control Weaknesses and Information Uncertainty.pdf

Internal Control Weaknesses and Information Uncertainty M.D. Beneish, M. Billings, L. Hodder Kelley School of Business Indiana University March 1st, 2005 Corresponding Author: Leslie Hodder Tel: (812) 855-9951 e-mail: lhodder@ Internal Control Weaknesses and Information Uncertainty Abstract Using a sample of 336 firms making reports required by the Sarbanes-Oxley Act, we examine the effect of mandated internal control weaknesses disclosures on information uncertainty for disclosing firms and for size- and performance-matched non-disclosing firms. We find a significantly negative (weakly positive) price response for disclosing (non-disclosing) firms consistent with resolution of information uncertainty in both groups. For disclosing firms we find that the negative market response to disclosure is exacerbated by conditions associated with higher inherent reporting risk, including auditor turnover and high-risk industry membership. However, we find that the negative market response to disclosure is mitigated when the firm has engaged a high quality auditor. In addition, we find that the negative market reaction for disclosing firms is dampened when the firm’s previously reported earnings have an abnormally high accruals component. This result is consistent with the disclosure having lower information content when poor earnings quality has already been conveyed by high abnormal accruals. JEL Classification: G14, G18, G30 Keywords: earnings quality; information uncertainty; reporting credibility; Sarbanes-Oxley; regulation 1. Introduction Recent accounting scandals have led to increased interest into the determinants and consequences of low financial reporting