What did the market learn from internal controls reporting?

A big advantage of internal controls reporting under SOX 404 was to give investors an early warning of disclosure problems, thereby restoring confidence in markets. I've argued that efficient markets, among other devices, already provide a lot of protection. See, e.g, here, and my book with Butler, which summarizes evidence through about last spring.

Here's some additional evidence for this hypothesis: Ghosh and Lubberink, Timeliness and Mandated Disclosures on Internal Controls under Section 404. The paper looks at what the market already knew about firms before 404 disclosures. Here's some of the abstract:

We find that firms with higher probabilities of reporting internal control weaknesses over the pre-disclosure period had: (1) lower earnings response coefficients, (2) less favorable common stock rankings and debt ratings, (3) higher cost of debt, and (4) larger errors in analysts' earnings forecasts. Finally, over the pre-disclosure period and at the time of the mandated disclosures we find that firms with internal control problems paid significantly higher audit fees.

The authors conclude:

our results suggest that sophisticated capital market participants can discriminate between firms with high and those with low probabilities of internal control problems. If timeliness is one prime reason for the disclosures on internal controls, our results suggest that the effectiveness of the initiatives under Section 404 to restore investor confidence in financial reporting may be limited.