An Evaluation of Repeated Material Weakness Disclosures

• In Event: Accounting Information Systems

Abstract

The objective of this study is to investigate the relationship between internal controls quality and earnings management by observing instances of repeated material weakness disclosure. Where others have found evidence that material weaknesses corresponded with increased earnings management, we posit that prolonged periods of ineffective internal control will exacerbate this relationship. Although other researchers have performed intertemporal analyses of material weakness firms, this is the first study to examine this question in the context of earnings management. We use material weakness disclosure from the auditor report on internal controls over financial reporting from Securities and Exchange Commission (SEC) Form 10-K as evidence of weak internal controls. We classify firms into four separate groups based on the persistence of ineffective internal controls. Our results present a statistically significant, positive, and monotonically increasing relationship between the number of consecutive years of ineffective ICFR and income increasing discretionary accruals.

Authors

• Bill Heninger, Brigham Young University

• Mason Snow, Arizona State University - Tempe