Venture Capital and the Disclosure of Material Weaknesses in Internal Control

• In Event: Accounting Quality and Internal Controls

Abstract

The Sarbanes-Oxley Act requires management and board of directors to be involved in establishing and maintaining good quality internal control systems and the evaluation and disclosure of any deficiencies or weaknesses that could potentially result in a material error. We find that venture capital backing is negatively associated with disclosures of material weaknesses in internal control. We show that material weakness disclosure is much more likely to be informative for firms backed by VCs: material weakness disclosure is followed by subsequent financial restatements for VC-backed firms, but not other firms. Furthermore, we find that firms backed by more reputable VCs have more effective controls as evaluated by management and auditors.

Authors

• Douglas Cumming, York University - Schulich School of Business

• Lars Helge Hass, Lancaster University Management School

• Linda Ann Myers, University of Arkansas-Fayetteville

• Monika Tarsalewska, University of Exeter Business School