Internal Control Weaknesses, Information Asymmetry and Market Liquidity : Evidence from SOX Section 404

This study explores the effect of internal control weakness (hereafter ICW) and their remediation on market liquidity, as measured by bid-ask spreads, for firms filed Section 404 reports with the SEC. First, we find that spreads are wider for ICW firms than for non-ICW firms. Such an association is primarily driven by firm-level weaknesses. Second, we find that a decrease in spreads for firms remedying previously weakness relative to firms which do not remedy their weakness. Further analyses indicate that spreads would decrease with information precision, irrespective of public or private information. More importantly, however, market specialists perceive ICW per se as an indicator of higher information risk and thus set wider bid-ask spreads than what would be expected otherwise, regardless of its effect on the precision of the information. Our results are robust after using alternative proxy for ICW, controlling for the endogeneity effect, and using alternative event windows