Predicting Internal Control Weaknesses : Evidence from Audit Fees and Financial Reporting Quality in the Pre-SOX US Era, UK and Australia

Based on a model developed in prior studies (e.g. Ogneva et al. 2007), we first use US data to predict the likelihood that a firm has material internal control weaknesses (ICW). We then show, using this model, that firms in the pre-SOX era, in UK and in Australia with a higher predicted likelihood of ICW are associated with significantly higher audit fees and lower quality of financial reporting, measured in terms of earnings persistence, discretionary accruals and accruals quality. These results suggest that the prediction model developed can be used as an analytical tool by both auditors and investors to identify firms with a high likelihood of ICW in other similar jurisdictions