Effect of Matherial Weaknesses on Stock Exchange Market

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EFFECTS OF MATERIAL WEAKNESS ON STOCK EXCHANGE MARKET
The impact of Sarbanes Oxley Act in companies’ share price

Ronnie Damonte

Month Year

School of Business Administration

TABLE OF CONTENTS:

1. INTRODUCTION3
1.1 Background Information.3
1.2 Objectives of the Research.3
1.2 Research Questions.4
1.3 Methods.4
2. SARBANES OXLEY ACT5
2.1 What is the “Sarbanes Oxley Act”?5
2.2 SOX genesis.5
2.2.1 Toward the SOX.5
2.2.2 The development of SOX bill.6
2.3 Structure and contents of Sarbanes Oxley Act.8
2.3.1 - 100s Public Company Accounting Oversight Board.8
2.3.2 - 200s Auditor Independence.8
2.3.3 – 300s Behavior and Compensation of CEO, CFO and professional advisors.9
2.3.4 – 400s Disclosure Rules.11
2.3.5 – 500s Conflicts of Analyst Interest.12
2.3.6 – 600s Funding; 800, 900, 1100s Disciplining Transgressors.13 2.4 SOX Section 404.13
2.4.1 Overview of Section 404.13
2.4.2 Internal Auditor Role in Section 404.14
2.4.3 Definition of deficiencies in internal control system.15 2.5 Market reactions after SOX.16
3. IMPLEMENTATION OF THE RESEARCH18
3.1 Selection of the study sample.18
3.2 Research methodology.21
3.2.1 Average variation analysis.21
3.2.2 Gaussian distribution analysis.22
4. EMPIRICAL TEST AND RESULTS27
4.1 Introduction.27
4.2 Results of the average variation analysis.28
4.2.1 Calculation of the company stock trend.28
4.2.3 Calculation of the average variation.29
4.3 Results of the Gaussian distribution analysis for the entire sample.32 4.4 Results of the Gaussian distribution analysis applied to the type of industry.35
4.4.1 Automotive and transport.35
4.4.2 Construction.36
4.4.3 Consumer product manufacturers.37
4.4.4 Consumer services.38
4.4.5 Electronics.39
4.4.6 Energy and utilities.40
4.4.7 Financial services.41
4.4.8 Industrial manufacturing.42
4.4.9 Media.43
4.4.10 Pharmaceutical.44
4.5 Results of the Gaussian distribution analysis applied to the company size.45
4.5.1 Small size companies.46
4.5.2 Medium size companies.46
4.5.3 Large size companies.48
5. CONCLUSIONS50
REFERENCES52
APPENDICES56
Appendix 1: Share price analysis per each selected company over a period of six months.56

1. INTRODUCTION

1.1 Background Information.

In recent years Sarbanes Oxley Act (the Act or SOX hereafter), a corporate law of United States has brought significant changes in the governance, accounting, auditing, and reporting environment of firms traded in American securities markets. Under the new regime of SOX, public companies must have a system of internal controls, management must make disclosures and attestations about the internal controls, and the external auditors must also test and evaluate the system. Important internal control deficiencies, called technically material weakness, could lead the auditor to conclude that internal control over financial reporting is not effective.

In my role of Senior Consultant in Deloitte Touche Tohmatsu, my employer has asked me to implement a research in order to understand the effect on market share price of material weakness. In fact, negative market reactions could lead some companies to apply a delisting program, decreasing the business opportunities regarding SOX consulting and auditing prospective for Deloitte Touche Tohmatsu.

1.2 Objectives of the Research.

In an attempt to increase investor confidence in financial reporting, the Sarbanes Oxley Act mandates management evaluation and independent audits of internal control effectiveness. Motivated by the ongoing debate on the economic impact and consequences of SOX, this paper investigates the effects of the Act in the Stock Exchange Market, by examining market reactions to the disclosures of a material weakness during the evaluation of company internal control system. We use SOX 404 audit opinions to assess how announcements of a material control weakness affect...
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