[I]n the longstanding controversy over 404(b), the voice of one constituency has been conspicuous by its absence — and ironically, it’s the very group the regulation supposedly protects: namely the investment community. Whether the provision actually holds value to investors has remained unclear.
Now, the January issue of the The Accounting Review, an American Accounting Association journal, includes the first study whose primary purpose is gauging investor demand for internal controls (IC) audits….Are investors justified in taking a dim view of opt-outs? In a word, yes. Companies that choose the option, the study revealed, are more likely to misstate their finances in the post-acquisition year.
The authors also pointed to other recent research concluding opt-out companies also do worse than opt-ins with respect to future returns on assets and short- and long-term stock performance.
The new paper’s findings are based on an analysis of 1,803 acquisitions by 925 companies over a nine-year period. An acquisition was included in the sample if the purchaser was a U.S. company subject to SOX 404(b), was audited by a Big Four accounting firm, and bought 100% of the target company.
Targets had market capitalizations at least 1% of their acquirers’ and would have been large enough on their own to be subject to 404(b).
The professors saw their research as informative to policymakers. “Aside from the PCAOB’s recent focus and inspection efforts, regulators have continually reduced the scope and extent of mandated internal control audits,” they wrote. “Our results suggest that future reductions … may be viewed negatively by investors.”