Timeliness and Mandated Disclosures on Internal Controls under Section 404Õ

The new mandated disclosures on internal controls under Section 404 of the Sarbanes-Oxley Act (2002) are expected to enhance investors ’ confidence in financial reporting through timely identification of internal control problems of firms. We provide new insights on the timeliness argument by analyzing the pre-disclosure period (specifically the years 2001 and 2002). We find that firms with higher probabilities of reporting internal control weaknesses over the pre-disclosure period had: (1) lower earnings response coefficients, (2) less favorable common stock rankings and debt ratings, (3) higher cost of debt, and (4) larger errors in analysts ’ earnings forecasts. Finally, over the pre-disclosure period and at the time of the mandated disclosures we find that firms with internal control problems paid significantly higher audit fees. Collectively, these results are generally inconsistent with the hypothesis that the disclosures under the Sarbanes-Oxley Act fostered timely identification of internal control problems