Enterprise Risk Management and Financial Misconduct

• In Event: Financial Misconduct and Auditor Busyness

Abstract

This study examines the impact of enterprise risk management (ERM) programs on corporate financial misconduct. ERM represents a structured, holistic approach to managing the entire portfolio of risks faced by an enterprise (COSO 2004, 2009). Theoretically, we expect that ERM is associated with less financial misconduct because ERM can effectively reduce opportunities for managers’ engagement of financial misconduct by enhancing audit and internal control effectiveness. It can also reduce incentives for managerial financial misconduct by 1) emphasizing reputation risk management, 2) mitigating managerial short-termism, 3) reducing need and cost of external financing, and 4) alleviating financial distress. Since the adoption of ERM is voluntary, to alleviate endogeneity concerns, we use two-stage least squares (2SLS) and a differences-in-differences design. Our analyses are conducted based upon hand-collected data of ERM adoptions among S&P 500 firms from 1990 to 2017. Consistent with our expectation, we find that ERM adoption is associated with less financial misconduct measured by levels of discretionary accruals, AAER violations, class action lawsuits, and financial restatements. The deterrent effect of an ERM on financial misconduct becomes stronger as the ERM becomes more mature over time. These results are robust after controlling for internal control over financial reporting (ICFR) and alternative model specifications controlling for firm fixed effects. Our findings suggest that ERM is beneficial to financial reporting quality and have implications for the debate on ERM’s benefits to enterprises.

Authors

• Evan Eastman, Florida State University

• Chan Li, University of Kansas

• Lili Sun, University of North Texas

• Jianren Xu, University of North Texas