Unintended Consequences of Internal Controls Over Financial Reporting

• In Event: Accounting Behavior

Abstract

This study investigates the impact of the internal controls over financial reporting requirements (ICFR) on the decision-making of corporate tax executives. Specifically, do the potential capital-markets consequences of a disclosed material weakness impact executives’ decisions? We examine the decisions of tax executives to disclose an error and amend a prior year return when the cause of the error will be classified as a significant deficiency or a material weakness. We find that tax executives are less likely to disclose (amend) when the cause of the error will be classified as a material weakness. When facing a material weakness, 16.7% of tax executives would not disclose the error. 9.7% are, in fact, willing to forgo a large tax refund to avoid disclosing the material weakness. These results indicate the required ICFR disclosure rules have unintended consequences. If executives do not disclose internal control deficiencies, the reliability of financial reporting is limited.

Authors

• Victoria Jane Hansen, University of North Carolina-Wilmington

• Richard White, University of South Carolina