Are voluntary internal control weakness disclosures in initial public offerings associated with managerial ability and subsequent financial reporting quality?

Abstract

This study examines whether voluntary disclosure of internal control weaknesses (ICWs) in IPO registration statements is associated with managerial ability and subsequent SOX 404 adverse audit opinions. Using a sample of IPO registrants that voluntarily disclosed ICWs in their registration statements, we examine the relationship between ICW disclosure, managerial ability, and subsequent material weaknesses in internal control. We find that IPO registrants with higher managerial ability are more likely to disclose ICWs voluntarily than other registrants. Further, we find evidence that registrants that include voluntary ICW disclosures are more likely to subsequently receive an adverse SOX 404 audit opinion. Additionally, we find evidence that registrants are associated with negative cumulative abnormal returns when an auditor issues an adverse SOX 404 auditor opinion regardless of whether the ICWs were disclosed in the registration statement.