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Internal Control Weaknesses and Client Risk Management
Randal Elder, Syracuse University
Yan Zhang, State University of New York at Binghamton
Jian Zhou, State University of New York at Binghamton
Nan Zhou, State University of New York at Binghamton
ABSTRACT. We study auditors’ client risk management in the SOX 302 period and 404 period. In both periods, firms with internal control weaknesses (ICW) are charged with higher audit fees. When we further separate ICW into company-level and account-specific weaknesses, the audit fee premium for company-level weaknesses is significantly higher than that for account-specific weaknesses. Firms newly identified with ICW are encumbered with greater audit fee increases from the 302 period to the 404 period. ICW firms are more likely to be flagged with a modified audit opinion in the 404 period only. Auditor resignations are more likely for ICW firms, especially for those with company-level weaknesses, in both periods, and are more likely for firms with account-specific weaknesses in the 404 period only. Our comprehensive evidence suggests that auditors use an array of strategies to manage client-related risk, and become more stringent in applying these strategies in the 404 period.
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