Do Shareholders Care about “Surprise” Internal Control Weakness Disclosures?

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. We find that shareholders at accelerated filers with surprise MW disclosures are more likely to vote against auditor ratification (by a factor of about 1.4 times) than at companies with “no-surprise” MW disclosures. These findings suggest that shareholders may at least partly blame auditors and hold them responsible for the surprise MW disclosures. Internal control disclosures necessarily involve professional judgment, but the results indicate that for shareholders, earlier disclosure of such problems is preferable to waiting until the year-end (and perhaps hoping that the problems will be resolved).