An Analysis of Multiple Consecutive Years of Material Weaknesses in Internal Control

Gordon, Lawrence A.; Wilford, Amanda

doi:10.2308/accr-50211

Cited by 69 publications

(47 citation statements)

References 24 publications

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“…Studies using equity data have yielded mixed findings regarding the association between internal control quality and the cost of equity (Ogneva et al 2007; Ashbaugh- Skaife et al 2009;Gordon and Wilford 2012). Several studies use debt market data-such as bank loans and public bonds-to investigate the relationship between internal control quality and credit spreads, but these studies have also produced inconsistent results.…”

Section: Introductionmentioning

confidence: 99%

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Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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i Internal Control Quality and Credit Default Swap SpreadsSYNOPSIS: This paper presents the first study on the effects of internal control quality on derivatives pricing. Specifically, we utilize data from the credit default swap (CDS) transactions of well-monitored companies to examine the relationship between the quality of internal control and the cost of debt. The CDS data we employ are advantageous for our analysis because CDS contracts are comparatively more homogeneous, standardized, and liquid than bank loans and public bonds. We find that CDS spreads increase around the disclosure of internal control material weaknesses (MWs) and that, all else equal, companies experiencing MWs with respect to internal control have higher CDS spreads than companies with effective internal control.Moreover, companies with company-level MWs have higher CDS spreads than those with less severe, account-specific MWs. In addition, remediating internal control MWs is associated with a decrease in CDS spreads. Our study offers a new perspective on the relationship between the quality of internal control and the cost of debt. These conflicting results may be due to heterogeneous characteristics and measurement issues in using bank loans and public bonds to measure credit spreads. Covenants, embedded optionalities (such as callability and convertibility), and other complicating factors associated with bank loans and public bonds may distort the relationship between credit risk and internal control quality. Furthermore, because information on bank loans is only available when companies receive new loans, researchers are relegated to three-or four-year windows in their observations of changes in loan spreads (Dahilwal et al. 2011). By contrast, CDS contracts are relatively homogeneous and standardized, and CDS spreads reflect credit risk better than loan or 3 bond spreads (Shivakumar et al. 2011;Callen et al. 2009) because the CDS market is not as plagued with the liquidity issues that affect the public bond and bank loan markets. Therefore, CDS spreads are a superior means of examining the impact of internal control quality on credit pricing.We expect CDS spreads to be positively related to internal control MWs for two reasons.First, a firm that is experiencing MWs in internal control suggests that its financial reporting may be unreliable, which thereby increases the perceived information risk from the perspective of a credit investor. Such information risk related to unreliable information sources leads an investor to charge a higher credit risk premium (e.g., Duffie and Lando 2001;Lambert et al. 2007).Second, internal control MWs make it easier for managers to misappropriate a company's assets, which increases the default risk. For example, Skaife et al. (2013) report that the profitability of insider trading is significantly greater in firms with internal control MWs, which suggests the risk of expropriation of outside shareholders when there are weak internal controls.In an examination of the period from November 15, 2004, ...

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Section: Introductionmentioning

confidence: 99%

“…Gordon and Wilford (2012) use a more recent sample of internal controls under SOX 404 to revisit the relationship between internal control quality and the cost of equity and suggest that internal control weaknesses are related to higher costs of equity.…”

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confidence: 99%

Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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“…The above discussion of the GL Model pointed out that treating cybersecurity as an explicit part of a firm's internal control system for financial reporting could help a firm better understand and identify the ex ante probability that it will in- 12 Internal control is "a process for assuring achievement of an organization's objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies." (see: https://en.wikipedia.org/wiki/Internal_control).…”

Section: Hypothesesmentioning

confidence: 99%

“…To our knowledge, this is the first 3 Sections 302 and 404 of SOX specifically address the internal control requirements for the CEO, CFO and external auditors of firms. For a further discussion of these requirements, as well as issues related to material weaknesses in corporate internal controls, see the paper by Gordon and Wilford [12].…”

Section: Introductionmentioning

confidence: 99%

“…12 In fact, a strong internal control system plays, or at least could play, an important role in reducing a firm's ex ante probability of incurring a cybersecurity breach (or breaches) due to its focus on the effective/efficient operations of an organization and its focus on having an organization comply with relevant laws, regulations, and policies. Accordingly,…”

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confidence: 99%

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Empirical Evidence on the Determinants of Cybersecurity Investments in Private Sector Firms

Gordon¹,

Loeb²,

Lucyshyn³

et al. 2018

JIS

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Investments in cybersecurity are critical to the national and economic security of a nation. There is, however, a strong tendency for firms in the private sector to underinvest in cybersecurity activities. This paper reports the results of a survey designed to empirically assess whether treating cybersecurity as an important component of a firm's internal control system for financial reporting purposes serves as a driver for private sector firms to invest in cybersecurity activities. The findings, in this regard, are significantly positive. The study also shows that a firm's concern over the risk of incurring a large loss due to a cybersecurity breach and the degree the firm treats cybersecurity investments as generating a competitive advantage are drivers of the level of private sector investment in cybersecurity activities. The implications of the empirical results for designing public policies to mitigate the tendency of private sector firms to underinvest in cybersecurity are also explored.

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Persistent internal control failures: Examining multiple consecutive years of disclosing material weaknesses

Tian,

Mei,

Tang

2024

J Corp Accounting Finance

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In this study, we analyze a sample of accelerated filers that have reported material weaknesses (MWs) in their internal controls for multiple consecutive years. The recent emphasis by the Securities and Exchange Commission on improving accounting and controls within public companies has led to heightened scrutiny of firms with ongoing MW disclosures. Analyzing data from 2004 to 2021, we find that approximately one‐third of MW observations are for 2 or more consecutive years, with the longest duration being 12 years. Our research shows that these firms face progressively higher audit fees and longer audit report lags for each additional year of MW disclosure. Firm–years with long‐standing MW disclosures (5 or more consecutive years) have the highest audit fees and the longest audit report lags. Our findings also reveal a significant increase in the likelihood of misstatements during the first and second consecutive years of MW disclosures, and a consistent and notable rise in discretionary accruals over the initial 4 consecutive years of MW reporting for these firms. Overall, our results highlight the financial repercussions for firms that do not promptly address MWs in their internal controls. These consequences include higher audit fees, extended audit report lags, and declining financial reporting quality.

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An Analysis of Multiple Consecutive Years of Material Weaknesses in Internal Control

Cited by 69 publications

References 24 publications

Internal Control Quality and Credit Default Swap Spreads

Internal Control Quality and Credit Default Swap Spreads

Empirical Evidence on the Determinants of Cybersecurity Investments in Private Sector Firms

Persistent internal control failures: Examining multiple consecutive years of disclosing material weaknesses

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