CEO Traits and Internal Control Deficiency Probability: Evidence from CEO Risk Conservatism and Organizational Identification

This paper uses firms' disclosures of internal control problems prior to audits mandated by Section 404 of the Sarbanes-Oxley Act (SOX) to investigate the economic factors that expose firms to internal control failure risks and managements' incentives to discover and report internal control deficiencies (ICDs). We find that firms making pre-SOX 404 ICD disclosures typically have more complex operations, recent changes in organization structure, more accounting risk exposure, fewer resources to invest in internal control and higher incidence of auditor resignation relative to firms that do not report internal control problems. Regarding incentives to discover and report internal control problems, we find that ICD firms have more prior SEC enforcement actions and restatements of financial statements, are more likely to use a dominant audit firm, and are more likely to have concentrated institutional ownership. Our findings are important in developing expectations about determinants of internal control problems across all SEC registrants including non-accelerated filers that are not yet required to comply with SOX 404, as well as providing baseline evidence for evaluating the discovery and reporting of ICDs under mandated internal control audits.

This research empirically examined a central claim of the social identity approach to leadership in the context of organizational change, namely that group prototypical leaders possess a ‘special credit’ in leadership performance and consequent follower support. We investigated leader prototypicality in comparison to and combined with change leadership and explored its boundaries focusing on organizational identity strength. Furthermore, we situated our analysis in two countries, Austria and Germany, that differ along cultural dimensions known to influence the effectiveness of leader group prototypicality. In our study of 207 Austrian and 206 German employees, we found that leader prototypicality, change leadership, and organizational identity strength each uniquely predicted perceived leader support, both in the combined sample and within each country. Furthermore, we observed the hypothesized two-way interaction between leader prototypicality and change leadership across these samples, as well as a three-way interaction with organizational identity strength in the combined and Austrian samples. Change leadership was less predictive with increasing leader group prototypicality, particularly in organizations with strong organizational identity. We interpret this as evidence of a ‘change credit’ for prototypical leaders, allowing them to compensate for a deficit in change-specific leadership behaviours, especially in contexts where organizational and leader identities are salient. MAD statement Our study investigates how leaders who embody their group's identity can more effectively drive organizational change, requiring fewer change management efforts to secure follower support. By exploring the idea of ‘change credit’ among Austrian and German employees, we highlight the critical role of social identity leadership, alongside a strong team and organizational identity, in achieving successful organizational transformations. This research contributes to Sustainable Development Goals 8 (Decent Work and Economic Growth) and 9 (Industry, Innovation, and Infrastructure) by offering scientifically-backed insights into more effective leadership strategies during challenging transitions in companies and economies.

The literature shows that a firm’s environmental information disclosure is affected by internal and external factors. However, it is unclear whether internal control positively impacts a firm’s green information disclosure. We collected data from the period 2010–2016 from either environmental reports or the environmental section of social responsibility reports of A-share listed companies in the heaviest polluting industries of the Chinese capital market, 1603 companies in total, and established an evaluation index for measuring firm greenness. Our research indicates that the level of internal control was positively correlated to the firm’s greenness level, and deficiencies in internal control were negatively correlated to the firm’s greenness level, indicating that high-quality internal control improves company green information disclosure. Pertaining to property rights, the internal control of state-owned enterprises had a significant effect on improving the level of environmental information disclosure. Among five elements of internal control, the internal environment, information and communication elements had a significant positive impact on firm greenness. Compared with samples with uncorrected major deficiencies in internal control, rectified companies’ environmental information disclosure was greener. These findings provide empirical evidence for a comprehensive understanding of the non-financial reporting goals of firm internal control, and will become a useful reference for firm green governance decision-making.

The study aims to identify in accordance with the methodology suggested by COSO, the level of disclosure of risk factors and the disclosure of deficiencies in internal control Brazilian companies with ADRs. To this end, it proceeded descriptive as to objectives, quality and quantity as the approach to the problem and documentary as methodological procedures. For data analysis, there was content analysis to later use descriptive statistics, and the research sample comprises 25 companies with Brazilian ADRs and data are for the period of 2014. The main results They demonstrated that there is no uniformity in the disclosure level among enterprises and that the risk disclosures with greater frequency is the strategic (44.91%) and less disclosure is the image risk (0.88%). The disclosure of deficiency in internal control It proved in eight of the 25 companies studied, and the consolidated results point that organizations with effective internal controls tend to highlight the risks more frequency. The t-test showed up significant at 10% for the risk of image, as that firms with deficiencies in internal control have a higher frequency in disclosure of this type of risk.

We examine detection, remediation and severity classification of deficiencies in tax-related internal controls identified under Sarbanes-Oxley Section 404. Our data comprise internal control deficiencies (ICDs) identified by company personnel and auditors, provided by several large auditing firms. We find that relative to ICDs in other accounts, tax ICDs are less likely to be remediated prior to yearend, are more likely to be severe, and are more likely to have failed to prevent a misstatement. Results show that companies under financial stress are more likely to have tax ICDs, and less likely to remediate those problems, implying that financial stress inhibits attention to internal controls over taxes. We find more severe tax ICDs among smaller, riskier companies lacking a high quality internal audit function. Investigating specific types of tax IDs, we find that severity classifications are higher for flaws in controls relating to the tax provision, deferred taxes, and compliance.

Different and valuable benefits and advantages of strong and robust organizational identity such as increasing organization’s activities legitimacy, improving the ability of organization in attracting sources, providing appropriate backgrounds in attracting empowered human source as well as increasing fame and organizational reputation can be regarded as some of the most important causes of the wide interest in the issue of organizational identity. So, knowing organizational identity as a complex social and valuable resource which achieves valuable competitive advantages is critical; and, the knowledge of more managements and various organizations’ directors, in particular the organizations which are much concerned with a wider population, is being variously judged and evaluated (Yazdani, 2005). Strong organizational identity among employees is followed by higher motivation and trying toward organizational citizenship behavior which, according to previous studies, can improve performance and achieving organizational goals and values. In other words, organizational identity changes individual social attitudes and cause individuals to introduce themselves by the organization. Once employees are introduced by its organization, they show higher levels of organizational citizenship behavior; as these behaviors are not far from role behaviors. Key terms: Organizational identity, organizational intervention, citizenship behavior, organizational ranking

We predict a negative relationship between internal control effectiveness and opportunistic insider trading based on agency theories. Empirical evidence on the profitability, intensity and timing of insider trades supports the prediction. Insider trading profitability is higher for firms with internal control deficiencies than those without. Insider trading profitability decreases sharply after internal control deficiencies are exposed and decreases further when those deficiencies are remediated. Insider trading intensity is higher for firms with internal control deficiencies, but it drops significantly when such deficiencies are exposed. After internal control problems are exposed, insider trades become more concentrated in short windows immediately following earnings announcements, consistent with firms adopting blackout policies to specifically restrict insider trading as a part of their effort to improve internal control. Lastly, the increase in the likelihood of blackout policies is more pronounced for firms that have more serious insider trading problems based on ex ante classification.

PurposeThis paper aims to explore whether an internal auditor’s evaluation of internal control deficiencies are influenced by the party with primary influence over the internal audit function and by the type of internal control deficiency.Design/methodology/approachA behavioral experiment is conducted with internal auditors as participants in a 2 × 2 between-subjects factorial design.FindingsResults indicate that internal auditors are less likely to evaluate a pervasive control deficiency related to “tone at the top” as a material weakness than a process-specific control deficiency. Furthermore, internal auditors are somewhat less likely to evaluate a process-specific internal control deficiency as a material weakness when management has primary influence over the internal audit function than when the audit committee has primary influence. It is also found that the best practice of internal audit oversight (i.e., primary oversight of internal auditors by the audit committee) may lead to potential internal under-reporting of instances where the audit committee represents a material weakness in internal control.Research limitations/implicationsLimitations of this research include lack of economic consequences (e.g. future pay and job loss) associated with the internal control decisions made by the participants; less concise information provided to the participants than would generally be available to them; and lack of generalizability of the findings beyond the specific company setting and internal control scenario portrayed in the case materials.Practical implicationsNot evaluating a pervasive control deficiency related to “tone at the top” as a material weakness seems to not fully align with relevant professional guidance and can possibly result in inaccurate internal information about the quality of internal controls. Furthermore, having an internal auditor’s evaluation of a process-specific internal control deficiency influenced by the party with primary influence over the internal audit function would not appear to align with relevant professional guidance. Finally, primary oversight by the audit committee of the internal auditors may lead to potential internal under-reporting of instances where the audit committee represents a material weakness in internal controls and, thus, possible communication of inaccurate internal control information.Originality/valueThis study is the first to address whether the party with primary influence over the internal audit function influences an internal auditor’s evaluation of internal control deficiencies.

Proposals for increased transparency and disclosure within audit reports are consistently met with conflict. Some suggest that auditor disclosures increase liability exposure for auditors, and should be the responsibility of management. Others suggest that such disclosures are beneficial to the users of the financial statements. Currently, the PCAOB is proposing a requirement for increased disclosure within the audit report on financial statements. This study proposes a similar requirement within the Section 404 auditor’s report on internal controls. A 2x2 between-subjects experiment manipulated the disclosure level (disclosed/not disclosed) and the auditability of the significant deficiency in controls (less auditable/more auditable) for a sample of 93 jury-qualified individuals. Results indicate that auditors may experience benefits of decreased liability exposure when they provide additional disclosure within the Section 404 report on internal controls. However, these favorable conditions are only present when the auditor discloses a deficiency in internal controls that is more auditable (less subjective), and not when the control is less auditable (more subjective). Results suggest that auditors are perceived as more blameworthy for their inaccurate judgments in subjective situations, and that this perception cannot be overcome by providing a disclosure within the 404 report. Implications for standard setters, auditors, and regulators are discussed.

Managers have decisive influence on in the establishment,implementation and evaluation process of enterprise internal control. But the existing literature rarely talked about the effects of management characteristics on internal control deficiency. This paper builds logistic models to examine the relation between management characteristics and internal control deficiencies. The empirical results show that the background characteristics of manager team, chairman and general manager such as tenure, profession, do have influence on internal control deficiencies. This paper manifests that it is necessary to consider the management characteristics in studying internal control. The conclusion is also helpful to establish perfect internal control and strengthen the construction of management team.

This paper investigates the effect of internal control deficiencies and their remediation on accrual quality. We first document that firms reporting internal control deficiencies have lower quality accruals as measured by accrual noise and absolute abnormal accruals relative to firms not reporting internal control problems. Second, we find that firms that report internal control deficiencies have significantly larger positive and larger negative abnormal accruals relative to control firms. This finding suggests internal control weaknesses are more likely to lead to unintentional errors that add noise to accruals than intentional misstatements that bias earnings upward. Third, we document that firms whose auditors confirm remediation of previously reported internal control deficiencies exhibit an increase in accrual quality relative to firms that do not remediate their control problems. Finally, we find firms that receive different internal control audit opinions in successive years exhibit changes in accrual quality consistent with changes in internal control quality. Collectively, our cross-sectional and intertemporal change tests provide strong evidence that the quality of internal control affects the quality of accruals.

This paper investigates the effect of internal control deficiencies and their remediation on accrual quality. We first document that firms reporting internal control deficiencies have lower quality accruals as measured by accrual noise and absolute abnormal accruals relative to firms not reporting internal control problems. Second, we find that firms that report internal control deficiencies have significantly larger positive and larger negative abnormal accruals relative to control firms. This finding suggests internal control weaknesses are more likely to lead to unintentional errors that add noise to accruals than intentional misstatements that bias earnings upward. Third, we document that firms whose auditors confirm remediation of previously reported internal control deficiencies exhibit an increase in accrual quality relative to firms that do not remediate their control problems. Finally, we find firms that receive different internal control audit opinions in successive years exhibit changes in accrual quality consistent with changes in internal control quality. Collectively, our cross-sectional and inter-temporal change tests provide strong evidence that the quality of internal control affects the quality of accruals.

We examine whether internal auditors with a strong organizational identity, defined as a perceived close relationship between the individual and their employer, provide overly lenient assessments of identified internal control weaknesses as compared to internal auditors whose organizational identity is weak and as compared to a control group of external auditors. We also examine whether increasing the salience of professional norms, that is, increasing the prominence in the internal auditors’ judgment process of information about the expectations of the professional group to which they belong, reduces bias in the internal auditors’ assessment of internal control weaknesses when their organizational identity is strong and whether external auditors who are aware that the internal auditor is adhering to the norms of their professional organization are more willing to rely on the internal auditor’s work. Results indicate that internal auditors with strong organizational identity provide internal control assessments that are less severe than internal auditors whose organizational identity is low, but when professional norms are made salient, internal auditors with strong organizational identity provide the most severe ratings. In addition, we find that external auditors who are aware the internal auditor adheres to professional norms are more willing to rely on the internal auditor’s control assessments. Implications of our results for the debate about the benefits and costs of in-house versus out-sourced internal auditors are discussed.

While earlier studies examine the impact of firm-specific characteristics on audit fees, no study has, to our knowledge, examined the relation between internal control deficiencies, investment opportunity, and audit fees. In this paper, we investigate the relation between investment opportunities, internal control deficiencies, and audit fees, after the enactment of the Sarbanes-Oxley (SOX) Act. Using a sample of 194 firms with the SOX compliant and non-compliant firms listed on the US stock exchanges, our analysis documents that higher audit fees are more likely for firms that have internal control deficiencies or higher growth opportunity. The evidence suggests that increased audit fees indicate an additional cost that firms should bear when their perceived risk is high to auditors when the business is growing and internal control mechanism is reported weak. However, the presence of higher number of independent directors on the board may signal that the organisation is struggling to mitigate the incidence of audit costs.

ABSTRACTThe Sarbanes‐Oxley Act (SOX) mandates management evaluation and independent audits of internal control effectiveness. The mandate is costly to firms but may yield benefits through lower information risk that translates into lower cost of equity. We use unaudited pre–SOX 404 disclosures and SOX 404 audit opinions to assess how changes in internal control quality affect firm risk and cost of equity. After controlling for other risk factors, we find that firms with internal control deficiencies have significantly higher idiosyncratic risk, systematic risk, and cost of equity. Our change analyses document that auditor‐confirmed changes in internal control effectiveness (including remediation of previously disclosed internal control deficiencies) are followed by significant changes in the cost of equity that range from 50 to 150 basis points. Overall, our cross‐sectional and intertemporal change test results are consistent with internal control reports affecting investors' risk assessments and firms' cost of equity.