Home Country Investor Protection, Ownership Structure and CrossListed Firms' Compliance with SOXMandated Internal Control Deficiency Disclosures

The objective of this study is to assess the effects of home country investor protection and ownership structure on the Sarbanes-Oxley Act (SOX)–mandated internal control deficiency (ICD) disclosures by foreign firms that are listed on the U.S. stock exchanges (hereafter referred to as cross-listed firms). Our research question is important for two reasons. First, cross-listed firms have become an increasingly important component of the U.S. equity market over the past decade. From 1990 to 2000, the number of foreign firms listed on NYSE and NASDAQ grew steadily from about 170 to over 750 with cumulative trading volume in these firms reaching more than $750 billion. As of 2002, foreign firms listed on NYSE represented nearly 17 percent of all NYSE listings (Coffee 2002). Second, while cross listing on the U.S. stock exchanges would subject foreign firms to the monitoring of multiple economic forces, Coffee (2002) indicates that financial disclosure is the only mandatory change incident to entering the U.S. capital markets. Prior research provides limited evidence concerning the extent to which cross-listed firms comply with U.S. mandatory disclosure requirements. In this study, we focus on SOX-mandated internal control disclosure provisions because internal control systems play a crucial role in ensuring the reliability of financial reporting. It is widely recognized that material internal control weaknesses give management the flexibility to manipulate financial reporting to conceal their expropriation activities (see, e.g., Public Company Accounting Oversight Board [PCAOB] 2004; Ashbaugh-Skaife, Collins, Kinney, and LaFond 2008; Doyle, Ge, and McVay 2007a). In addition, the SOX-mandated internal control disclosure provisions are regarded as the most costly and controversial provisions of SOX. Therefore, it is important to analyze cross-listed firms’ compliance with SOX-mandated ICD disclosure requirements. Prior research on non–cross-listed firms shows that home country investor protection and ownership structure have significant impacts on firms’ financial reporting behavior (e.g., Haw, Hu, Hwang, and Wu 2004; Leuz, Nanda, and Wysocki 2003). However, it is debatable whether home country investor protection and ownership structure have a