Does investment efficiency improve after the disclosure of material weaknesses in internal control over financial reporting?

We provide more direct evidence on the causal relation between the quality of financial reporting and investment efficiency. We examine the investment behavior of a sample of firms that disclosed internal control weaknesses under the Sarbanes-Oxley Act. We find that prior to the disclosure, these fi...

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Bibliographic Details
Published in:Journal of accounting & economics 2013-07, Vol.56 (1), p.1-18
Main Authors: Cheng, Mei, Dhaliwal, Dan, Zhang, Yuan
Format: Article
Language:English
Subjects:
Accounting methods
Causality
Disclosure
Effectiveness of internal control over financial reporting
Efficiency
Financial control
Financial reporting
Internal controls
Inventory control
Investment decision
Investment efficiency
Investment policy
Legislation
Market efficiency
Public Company Accounting Reform & Investor Protection Act 2002-US
Studies
U.S.A
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Summary:We provide more direct evidence on the causal relation between the quality of financial reporting and investment efficiency. We examine the investment behavior of a sample of firms that disclosed internal control weaknesses under the Sarbanes-Oxley Act. We find that prior to the disclosure, these firms under-invest (over-invest) when they are financially constrained (unconstrained). More importantly, we find that after the disclosure, these firms’ investment efficiency improves significantly. •Material weaknesses in ICFR are associated with investment inefficiency.•After the disclosure of ICFR weaknesses, the investment inefficiency gets mitigated.•These effects are robust to controls for earnings quality and various corporate governance mechanisms.
ISSN:0165-4101
1879-1980
DOI:10.1016/j.jacceco.2013.03.001