Do Managers Make Voluntary Accounting Changes in Response to a Material Weakness in Internal Control?

Abstract

This study examines whether managers make voluntary changes in accounting principle in response to a material weakness (MW). We find that managers are more likely to report voluntary changes in the same year as and year following a MW disclosure, a result largely driven by companies with a greater number of MWs. Auditor, CFO, CEO, and director turnover and restatements are not the primary driver of these results, although MW companies with new CFOs are more likely to make voluntary changes in the same year. Managers of MW companies justify voluntary changes as improving accounting information, conforming internal policies, and providing administrative benefits. MW companies that report voluntary changes in the same year and justify the changes as improving accounting are more likely to remediate at least one MW in the following year. Further, entity level MW companies with voluntary changes in the same year are associated with higher accruals quality than other entity level MW companies, and a similar result holds for companies with more MWs. These results suggest that MW companies likely report voluntary changes as part of a strategy to improve financial reporting processes and policies. Our study informs both internal control policymakers and accounting standards setters.