Complex Fair Value Measurements and Material Weaknesses : It's Not All Bad News

U.S. and international regulators and standard setters have criticized companies and audit firms for failing to establish and audit internal controls for complex fair value measurements (FVMs). In this study, we examine the association between FVMs and the likelihood of reporting a material control weakness, as well as settings in which this association may be reduced. We find that companies with FVM portfolios concentrated in Level 2 and Level 3 FVMs are more likely to report material weaknesses, confirming regulators' concerns that the FVMs are associated with lower financial reporting quality. However, we do not find this association for large companies, clients of audit firm industry experts, or clients of audit firms with FVM-specific expertise. These results suggest that despite the inherent complexity of Level 2 and Level 3 FVMs, company- and auditor-specific characteristics can impact companies' abilities to create an effective internal control structure around some FVMs