Corporate Internal Control Research Articles

Evidence from the United States on the Effect of Auditor Involvement in Assessing Internal Control over Financial Reporting

Securities regulators around the world are considering the costs and benefits of alternative policies for providing information to financial markets on corporate internal control. These policy options differ on the level of auditor involvement, among other dimensions. We examine the association of relative auditor involvement and auditor characteristics with Section 302 internal control disclosures made by US ‘non‐accelerated filers’ from 2003 to 2005. We find more material weaknesses disclosed in the fourth quarter, when there is relatively more auditor involvement, relative to the first three quarters. Clients of larger audit firms have higher disclosure rates (although they are probably less risky due to more stringent client acceptance standards), but this difference is due to fourth quarter disclosures. Audit firms with Section 404 experience also have greater material weakness disclosure, implying process improvement associated with knowledge sharing across engagements. Collectively, our results shed light on ways to increase the effectiveness of internal control regulation.

Backdating of Employee Stock Options: Signaling Effects for Corporate Governance and Internal Control Deficiencies

Backdating occurs when a company retroactively changes option grant dates to a date when its stock was trading at a relatively low price. Firm announcements of backdating have lead to adverse publicity from the media and negative pronouncements from academics regarding the economic effects and motivation of those involved. This research finds that backdating signals to the capital markets that these firms have ineffective governance systems and poor internal controls. Further, nearly half of the backdating investigations show none has occurred or it was unintentional. This indicates the media's negative attention and the impact on share prices was unwarranted in many cases.

The Cost of Internal Control and Corporate Governance in Latin America

As organizations hope to take advantage of Thomas Friedman’s flattened world, they must increasingly recognize that corporate governance and internal controls are no longer tools that are solely important for large multinational corporations in the European Union and the United States. This paper explores the interplay between Country Governance and Corporate Governance and how this interplay is critical for successful economic development in Latin America. In particular, it investigates the degree to which the impact of government corruption on the development of disclosure practices by both Multinational Corporations and Small and Medium sized Entities (SMEs) impacts on foreign direct investment. Moreover, these policies often affect the relationships that foreign corporations can facilitate under laws such as the US Foreign Corrupt Practices Act. Internal control and Corporate Governance are examined as tools that organizations implement rather than merely talk about.

Changes in Market Responses to Financial Statement Restatement Announcements in the Sarbanes-Oxley Era

We examine changes in the market's response to financial statement restatement announcements during the Sarbanes-Oxley (SOX) era. We define this era as beginning with the U.S. Department of Justice initiation of a criminal investigation into the collapse of Enron, and its attendant loss of billions of dollars of shareholder value, through the November 15, 2004, requirement that all U.S. companies with market capitalizations over $75 million must comply with SOX Section 404, which deals with corporate internal controls over financial reporting We divided the Sarbanes-Oxley era into pre- and post-SOX periods, with the dividing line concurrent with the signing of the Sarbanes-Oxley Act into law on July 30, 2002. The comparison of pre- and post-SOX periods shows that post-SOX, the negative impact on companies announcing restatements is reduced 71 percent on average (as measured by the cumulative abnormal return on days 0 and 1) and the positive market response to announced restatements is reduced by 33 percent. This translates into a net reduction in lost market value of $207 million per restatement announcement or $74.4 billion in total market value for the two-day announcement event window. We also find that this reduction is not due to the diluting effects of the increased number of statistically insignificant post-SOX market reactions to restatement announcements. Finally, our results indicate that after SOX became law, post-announcement abnormal returns exhibit statistically significant lower volatility and the trend in statistically insignificant market responses to restatement announcements no longer declines, thus indicating less uncertainty on the part of investors regarding the announcements of restating companies, and perhaps because investors believe the disclosed information conveyed by the restated financials is timelier and of higher quality.

Auditor independence revisited: The effects of SOX on auditor independence

Following a wave of accounting scandals, the Sarbanes–Oxley Act (SOX) was enacted on 30th July, 2002. The objective of the Act was to provide investors with better protection by establishing a new oversight board, improving corporate governance and internal controls, enhancing financial disclosure, and strengthening auditor independence.In this paper, we question the extent to which SOX actually improved auditor independence. We seek to shed some light on auditor independence-related issues by asking: What has the academy learned about SOX's impact on auditor independence in the five years since its enactment? Have researchers even examined key ramifications of SOX's requirements? If not, what areas need scrutiny? These are the issues considered here. In essence, we examine whether there is a gap between what regulators want to see addressed and what researchers have actually looked at with regard to auditor independence in the post-Sarbanes–Oxley period. The Securities and Exchange Commission (SEC) requirement to enhance auditor independence has been far reaching. It involves providing guidelines on matters relating to the provision of nonaudit services, partner rotation, audit engagement teams, auditor compensation and the role of the audit committees. Therefore, we expected to find a large number of academic research papers on this topic. Surprisingly, the number of such papers is very small, with the results inconclusive. Overall, the academy falls short of providing detailed guidance to the SEC and other regulators on the effectiveness of their guidelines in enhancing auditors’ independence. We hope that, after reading our paper, regulators and academicians will agree with us that much more research is needed before assessing the impact of SOX. A recent FEI survey shows that 78 per cent of financial executives agree that the cost of implementing SOX exceed its benefits. We hope financial executives, whether they hold this view or not, may also find an interest in reading our paper.Given strong trends toward globalisation of business and the concomitant easing of cross-border stock exchange listing requirements, we also suggest to regulators that insights into the structure of US auditing may be gleaned by examining apparently successful auditing innovations overseas.

Analyzing the Managers’ Trusteeship Economically in Sarbanes-Oxley Act

Sarbanes-Oxley Act, which aims at reforming and bettering the managers’ trusteeship, gives a great influence on the corporate governance and internal controls of more than thirty listed companies in America. This text applies the client-agent theory to analyze the significance of economics of the Act and shows that the essence of the Act is to reduce the cost of the incentive contract between the investors and the personnel owners and the measurement cost in implementation by strengthening internal control and emphasizing the managers’ trusteeship. The purpose of it is to achieve the accuracy and reliability of the corporate information disclosure so as to protect the investors and others objectives. It is of great significance for reference for Chinese businesses to better the corporate governance and deep reform.

Corporate Social Responsibility and Internal Control Revisited

Corporate Social Responsibility and Internal Control Revisited

Disclosure patterns in derivatives reporting by UK firms: implications for corporate governance

This paper provides a description of an empirical investigation into the disclosure of information concerning the use of derivatives and other financial instruments in corporate annual reports of UK firms following the introduction of Financial Reporting Standard 13 (FRS 13) 'Derivatives and other financial instruments ? disclosures'. The results indicate that the implementation of this standard was associated with a substantial increase in derivatives-related information available in corporate annual reports. It is argued that this increase in disclosure has implications for the corporate governance and internal control mechanisms of the reporting companies.

Takeover Bidding and Internal Corporate Control of Acquiring Firms

This paper explores the interaction between the internal corporate control mechanism of acquiring firms - managerial ownership and board dismissal of managers - and the incidence of efficient takeovers under asymmetric information about the type of manager of the acquiring firms. The internal control mechanism of acquiring firms needs to be designed so as to alleviate not only the conflict of interest between managers and minority shareholders in the acquiring firms, but also the free-rider problem of atomistic target shareholders. The results of this paper show that the efficiency of takeovers depends on the internal control mechanisms of acquiring firms. The results also provide several comparative static results on the incidence of efficient (or inefficient) takeovers and the optimal internal control mechanism of acquiring firms, and several implications on certain empirical patterns during takeover activity concerning the internal control mechanism of acquiring firms.

Change Management Controls Compliance With The Sarbanes-Oxley Act Of 2002: An Example From Practice

Publicly held firms and the assurance services industry are currently struggling with the implementation of standards set forth in the Sarbanes-Oxley Act of 2002 (SOX). How to meet and assess SOX standards is considered by professionals to be uncharted territory. This study reports the details of an actual SOX audit. An international computer component manufacturing corporation engaged information system auditors from a Big 4 firm to determine whether change management procedures in two areas in their Finance Department were compliant with SOX. Audit results indicated internal control deficiencies in the two areas audited. SOX compliance was thus determined to be weak and unreliable. In addition to reporting audit procedures actually used in practice to test SOX compliance, this case study presents key change management control procedures firms must have in place to be SOX compliant. We provide helpful practical guidance for corporations and audit firms involved with SOX compliance audits. In addition, this study has value for corporate internal control training sessions as well as general applicability for accounting information systems (AIS) and management information systems (MIS) courses.

After the scandals: A German-speaking perspective on management accounting research and education

As a reaction to recent corporate scandals, corporate law and accounting regulations have recently been modified in German-speaking countries. Despite changing corporate contexts and agendas, accounting research in these countries has been comparatively silent on issues of corporate governance. In this paper, we discuss this limited response, focusing particularly on the field of management accounting. In German-speaking countries, management accounting is conceived of in a specific way (usually referred to as Controlling). The traditions of such a practice and the associated academic school of thought have made it difficult for researchers to consider issues of corporate governance and internal control in more empirical depth. Pointing to the importance of investigating the actual use of accounting systems and, thus, the social and institutional context of accounting, we propose a strategy for research and education that would allow for more comprehensive insights into the role that (management) accounting might play in corporate scandals.

Audit Committee Quality and Internal Control: An Empirical Analysis

I examine the association between audit committee quality and the quality of corporate internal control. While information on the quality of internal control is not generally available, companies changing auditors are required to disclose any internal control problems that were pointed out by their predecessor auditors. The empirical results are based on a comparison of companies disclosing such internal control problems with a control sample of companies changing auditors but not disclosing internal control problems. Audit committee quality is measured in three dimensions: its size, its independence, and its expertise. The internal control problems are observed at two levels of increasing seriousness: reportable conditions and material weaknesses. The sample time period precedes the effective dates of recent policy changes regarding audit committees. The results indicate that independent audit committees and audit committees with financial expertise are significantly less likely to be associated with the incidence of internal control problems. This is true for both levels of internal control problems. The results are consistent with recent policy emphasis on audit committee independence and expertise.

Reflections on Corporate Governance and the Role of the Internal Auditor

The paper holds three main objectives. First to describe briefly what corporate governance is all about (what does it mean, where does it come from, how has it developed, etc ). Secondly to establish the relationship between corporate governance and internal control. And thirdly to reflect on the relationship between corporate governance and the internal auditor. Sooner or later every internal auditor is confronted with certain aspects of corporate governance. Perhaps the most difficult thing about corporate governance is to try to grasp its full meaning and its impact on the job of the internal auditor. Corporate governance means as lot of different things to a lot of different people depending on the context in which the term is used. For the internal auditor, corporate governance may just be a process aimed at contributing to the realization of the objectives of an organization, taking into account the expectations of all stakeholders involved and taking place within the boundaries of a number of hard and soft standards. Since it is the job of the internal auditor to help an organization to accomplish its objectives by bringing a systematic and disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes, the internal auditor has an important role in the corporate governance process. While traditionally the role of the internal auditor was to help the organization to maintain the system of internal control of its financial statements, a whole new range of new opportunities, possibilities and responsibilities present themselves in the wake of corporate governance. Moreover, corporate developments, along with more inquisitive stakeholders and assurance requirements, not only on financial but also on non-financial measurements and reporting, constantly increase the audit workload. In order to tackle these challenges, the internal auditor has to be resourceful in choosing the appropriate tool(s) from his toolbox to perform his task with care, prudence and dedication in order to provide the board with the reasonable assurance they expect. The fact that corporate governance encompasses so many different aspects, both hard and soft, indicates right away that perhaps not all these aspects can be measured that easily. While hard aspects largely coincide with aspects of compliance and are therefore easier to grade, soft aspects are often perceived in relation to internal and external customs, values and traditions.

Board Efficiency and Internal Corporate Control Mechanisms

We analyze the interactions between internal and external control mechanisms in a framework in which the board selects the CEO and then decides whether to retain or dismiss him after observing a signal regarding his ability. The novel aspect of our paper is that we consider both the hiring and the firing of the CEO by the board. The type of board is defined by its ability to select a good CEO, so that the quality of the CEO depends on the type of board. Then, the dismissal‐retention decision provides information not only on the quality of the CEO but also on the board's type. We show that the board's behavior depends on the pressure from the takeover market and on whether its type is publicly known. When the pressure from the takeover market is high and the type of board is private information, the board prefers not to dismiss the manager even if it has received a very low signal regarding his quality. Hence, our model endogenously derives a collusion between board and CEO in which the board does not fire a bad CEO. This behavior emerges as an attempt to hide the board's inability to accomplish the first task, CEO selection, by distorting the second task, the CEO retention‐dismissal decision.

Board Efficiency and Internal Corporate Control Mechanisms

Board Efficiency and Internal Corporate Control Mechanisms

Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems

Since 1973 technological, political, regulatory, and economic forces have been changing the worldwide economy in a fashion comparable to the changes experienced during the nineteenth century Industrial Revolution. As in the nineteenth century, we are experiencing declining costs, increaing average (but decreasing marginal) productivity of labor, reduced growth rates of labor income, excess capacity, and the requirement for downsizing and exit. The last two decades indicate corporate internal control systems have failed to deal effectively with these changes, especially slow growth and the requirement for exit. The next several decades pose a major challenge for Western firms and political systems as these forces continue to work their way through the worldwide economy.

Corporate Control Through Board Dismissals and Takeovers

This paper examines some policy issues related to the interaction between internal and external corporate control mechanisms—board dismissals and takeovers—by focusing on the information aggregation and other effects related to this interaction. We model the functioning of corporate control mechanisms as an example of a multilayered principal‐agent relationship in which shareholders delegate the task of monitoring management quality to the board and rely on the external takeover market to provide additional disciplining of the manager as well as of the board. This gives rise to two effects: (1) a substitution effect, whereby the takeover market partially substitutes for board dismissal of the manager, leading to greater lenience toward the manager by a board acting in the shareholders' best interest, and (2) a kick‐in‐the‐pants effect, whereby the board is stricter with the manager because it may be dismissed by a successful acquirer who views it as lax. The interaction of these two effects leads to various implications about the behavior of boards and potential acquirers. In particular, a well‐functioning internal control mechanism (the board) does not obviate the need for external control (takeovers). Moreover, somewhat counterintuitively, there may be a greater incidence of takeovers when the internal control mechanism is working well than when it is not.

Corporate Control Through Board Dismissals and Takeovers

This paper examines some policy issues related to the interaction between internal and external corporate control mechanisms - board dismissals and takeovers - by focusing on the information aggregation and other effects related to this interaction. We model the functioning of corporate control mechanisms as an example of a multilayered principal-agent relationship in which shareholders delegate the task of monitoring management quality to the board and rely on the external takeover market to provide additional disciplining of the manager as well as of the board. This gives rise to two effects: (1) a substitution effect, whereby the takeover market partially substitutes for board dismissal of the manager, leading to greater lenience toward the manager by a board acting in the shareholders' best interest, and (2) a kick-in-the-pants effect, whereby the board is stricter with the manager because it may be dismissed by a successful acquirer who views it as lax. The interaction of these two effects leads to various implications about the behavior of boards and potential acquirers. In particular, a well-functioning internal control mechanism (the board) does not obviate the need for external control (takeovers). Moreover, somewhat counterintuitively, there may be a greater incidence of takeovers when the internal control mechanism is working well than when it is not.

THE GOVERNANCE AND CONTROL OF VOLUNTARY CORPORATE SPIN-OFFS

We investigate the role that a voluntary corporate restructuring can play in the design of efficient internal corporate control mechanisms. To this end, we examine the post-restructuring internal control practices in 78 voluntary corporate spin-offs that were completed between 1972 and 1987. We find that the selection of the new CEOs, the design of their compensation contracts, and the staffing of the boards of directors and their compensation committees in the spun-off firms can be seen as ex ante efficient. These governance and control practices, however, are not strongly related to the observed positive market reactions to the spin-off announcements. The results indicate that equity reorganizations facilitate the implementation of efficient internal governance and control practices, but that other factors must influence the share price reactions to the announcement of such voluntary corporate restructurings.

Money Laundering, Regulatory Strategy and Internal Corporate Controls

Money Laundering, Regulatory Strategy and Internal Corporate Controls