Internal Control Quality and Analyst Forecast Behavior: Evidence from SOX Section 404 Disclosures

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Using a sample of companies that disclosed auditor-attested evaluation of internal control over financial reporting under the SOX Section 404 provision, this study examines the effect of internal control quality (ICQ) on analyst behavior. Our results reveal the following: First, analysts are less likely to follow firms with weak internal controls. Second, ICQ is inversely associated with analysts’ forecast error and forecast dispersion. Finally, analysts’ forecast revision per unit of current earnings surprises and convergence of analysts’ beliefs subsequent to the release of current earnings reports are higher for firms with effective internal controls than for those with weak internal controls. Our results are consistent with the notion that effective internal controls improve the quality of analysts’ forecasting decisions and analysts take into account the disclosed ICQ information when making their forecasting decisions.