Equity Incentives and Internal Control Weaknesses

Abstract

In this study, we examine whether the monetary incentives associated with equity ownership (broadly defined to include stock and stock options) induce managers to maintain strong internal controls. Supporting the notion that equity ownership provides management incentive to strengthen the company's internal controls we find that the likelihood of a material weakness in internal control decreases with increases in equity incentives. This result holds for both traditional regression analysis, as well as analysis conducted using propensity score matching. Further analysis suggests that these results are more closely related to company-level internal control problems, are more strongly associated with incentives provided by restricted equity, and are more highly correlated with CFO than CEO incentives.