Internal Control Weaknesses Research Articles

Open government data and firm value: A quasi‐natural experiment from China

AbstractThe Chinese government is actively promoting the utilisation of open government data (OGD) to unlock the intrinsic value of data assets. This study considers the establishment of local OGD platforms as a quasi‐natural experiment. We conducted our research using a sample of China's A‐share listed firms from 2007 to 2021 and employed the staggered difference‐in‐difference (DID) model to examine the impact of OGD on firm value. The empirical analysis reveals a significant positive effect of the establishment of OGD platforms on firm value, which is achieved by alleviating financing constraints, promoting corporate risk‐taking, and enhancing resource allocation efficiency as well as talent agglomeration. Heterogeneity analysis shows that OGD has a more pronounced impact on the value of firms operating in highly competitive industries, firms with weak internal controls, and firms located in non‐central cities. The findings presented in this paper provide valuable insights for promoting the deep integration of government data with enterprise management.

Regulatory Fragmentation and Operational Efficiency

ABSTRACTThis study employs a fragmentation index derived from Federal Register data to explore the relationship between regulatory fragmentation and operational efficiency. I find a positive association between regulatory fragmentation and operational efficiency, validated through various robustness checks, including entropy balancing, instrumental variable methods, fixed effects at different levels, change specification models, and alternative measures of operational efficiency. Additional analyses indicate that this positive association is more pronounced in firms exhibiting internal control weaknesses and facing higher operational uncertainty. Overall, my results suggest that although regulatory fragmentation poses challenges, it also creates opportunities for firms to enhance their operation efficiency. This research sheds light on the multifaceted effects of regulatory environments, providing valuable insights for policymakers and corporate strategists in managing regulatory complexities.

The Role of Fraud Opportunities in Procurement Irregularities at Public National Referral Hospitals in Nairobi County, Kenya

Procurement fraud is a major challenge in Kenya’s health sector, where it continues undermining the delivery of effective services. Although various regulatory and legislative measures have been implemented to address this issue, procurement fraud persists, especially in Nairobi County. Guided by the fraud diamond and routine activities theories, this study examined the role of fraud opportunities—including opportunities for collusion, ineffective control mechanisms, accountability gaps, poor tone at the top, and inadequate monitoring—in facilitating procurement fraud within public National Referral Hospitals (NRHs) in Nairobi County, Kenya. A cross-sectional descriptive survey design was used for the study. Data were collected from randomly selected procurement and staff in three NRHs using structured questionnaires. Correlation and simple linear regression analyses were then performed using SPSS. The findings reveal that fraud opportunities significantly influence procurement fraud as they explain 57.9% (R² = .579) of its variance. Key vulnerabilities include opportunities for collusion, weak internal controls, poor accountability mechanisms, and leadership deficiencies that create an enabling environment for fraudulent activities. The study concludes that opportunities for fraud arising from weak internal controls and inadequate monitoring are major contributors to procurement irregularities in public NRHs. Based on the results, we argue that there is a need for the implementation of comprehensive procurement policies, institutionalization of periodic audits, enforcement of accountability measures, and adoption of technological tools to deter fraud. Future studies should explore the interplay between fraud opportunities and other drivers, such as rationalization and capability, in different public sector settings.

Institutional investor distraction and stock price synchronicity

AbstractThis article examines the relation between institutional investor distraction and stock price synchronicity using extreme industry returns as an exogenous shock to investor attention. We find that institutional investor distraction is negatively associated with the quantity of firm‐specific information incorporated into stock prices. Underlying mechanisms that lead to our results are the decremental disclosure of valuable information and reduced efficiency of information dissemination. Further analyses imply that the negative impact of institutional investor distraction is more pronounced for firms with weaker internal control and lower market competition. This stock price synchronicity significantly increases financial constraints and weakens investment horizons.

Privacy Breaches and the Effect of Customer Notification

Laws requiring firms to disclose privacy breaches to their customers have been adopted extensively worldwide. However, the manner in which these laws affect the security protection behavior of firms disclosing a data breach is poorly understood. To shed light on this issue, we leveraged institutional theory and examined how U.S. state data breach notification laws (DBNLs), under which firms must notify customers of personal information breaches, influenced firm-level incidence of security breaches and how such influence manifested heterogeneously across firms. Exploiting the staggered enactments of DBNLs in a difference-in-differences analysis, we found that firms experienced a significant reduction in data breach incidents after the implementation of DBNLs. This effect was more pronounced among firms that were more reliant on sensitive customer data, operated in stricter privacy protection environments, or held more intangible and digital assets. We document evidence that compared to firms not subject to DBNLs, firms subject to these laws are more likely to appoint IT-specialized executives and remediate IT-related internal control weaknesses, which suggests potential channels that may facilitate DBNLs’ curbing of data breaches. We also found that the reduction in breach incidences following DBNL-mandated disclosure policies relates to both endogenous breaches and exogenous cyberattacks.

Internal Control Analysis and Fraud Prevention Efforts in Public Sector Accounting

The study examines the role of internal control in preventing fraud within public sector accounting by safeguarding assets, ensuring accurate financial reporting, and promoting operational efficiency. Internal control systems are built on control environments, risk assessments, control activities, communication, and monitoring. Weak internal controls, such as inadequate segregation of duties and poor oversight, often lead to fraud in the public sector. Effective measures, including audits, anti-fraud policies, ethical behavior promotion, and the use of technology for monitoring, can mitigate these risks. Strengthening internal control systems enhances financial integrity, protects public resources, and supports efficient governance.

An Examination of Management Tone in the MD&A in the Context of Fraud Pentagon

ABSTRACT We examine the association between management tone in management discussion and analysis (MD&A) and five elements of the fraud pentagon model of incentives, opportunity, rationalization, capability, and arrogance. Management tone is measured using a biased tone, and several proxies for fraud are constructed. Using a sample of 586 public companies listed on the Teheran Stock Exchange from 2013 to 2022, we find (1) auditor’s opinion, current ratio, capital expenditure, earnings management, and tax evasion as proxies for fraud incentives; (2) internal control weakness as a proxy for fraud opportunity; (3) CEO tenure and ability as proxies for fraud capability; (4) competition in the product market, industry tax evasion, and lack of political communication as proxies for fraud rationalization; and (5) narcissism and overconfidence as proxies for fraud arrogance are associated with management abnormal tone. We contribute to literature by examining relationships between fraud elements and the abnormal tone in MD&A. Data Availability: Data used in this paper are available from the public sources identified in the text and upon request from authors. JEL Classifications: M41; M42; M48.

Political corruption and cost stickiness: Evidence from China

AbstractThis study investigated the effect of local corruption on the cost behaviour of publicly traded firms in China over the period from 2007 to 2017. Our findings show that firms situated in regions with higher corruption levels tend to exhibit greater cost stickiness, primarily driven by managerial empire‐building incentives and rent‐seeking behaviours. This effect is particularly pronounced in firms subject to greater government intervention, weaker internal controls, fewer political connections, and less market competition. Furthermore, this corruption‐induced cost behaviour is found to negatively impact firm value. The results underscore the critical role of institutional environments, particularly corruption, in shaping corporate cost management strategies. This study provides valuable insights into how corruption influences economic outcomes for firms and offers guidance for managers, regulators, and investors to address these challenges and optimise cost management practices.

Fintech development, corporate tax avoidance and firm value

We examine the relationship between fintech development and tax avoidance, as well as investigate whether this relationship has an impact on firm value. Using the data from Chinese A-listed firms, we provide evidence that fintech development increases tax avoidance, which facilitates firm value. Moreover, we find that fintech raises after-tax income and future cash flow by facilitating firms to avoid tax. Fintech development is negatively associated with tax risk and positively related to the effectiveness of firms in capitalizing on tax preferences. We further determine that the positive effects of fintech are more pronounced among firms with low internal information quality, weak internal control, and more geographically dispersed operations. Digital transformation, cash flow uncertainty, and regional economic development are the important potential channels through which fintech development influences tax avoidance. Our results are robust to alternative measures and endogeneity issues.

Audit committee financial expertise and internal control weakness: does CEO overconfidence matter?

Purpose The presence of financial experts within audit committees (AC, hereafter) has been a central concern for regulatory bodies. These guidelines underscore the significance of having members with distinct financial acumen and proficiency on AC. The primary objective of this research is to explore the influence of financial expertise within AC on internal control weaknesses (ICWs, hereafter). Furthermore, another aim of this study is to examine the potential combined impact of CEO overconfidence on this correlation. Design/methodology/approach The statistical analysis has been done through the implementation of a multiple regression model by adopting a sample of 82 Jordanian companies, chosen from the years 2014 to 2020. Findings This research reveals that an AC with higher levels of financial expertise is linked to fewer ICWs. Upon further examination, this paper observes that this negative impact is primarily driven by the presence of accounting expertise, as opposed to nonaccounting expertise. It is also evident that CEOs with overconfidence may interfere with the decision-making processes of the audit committees, thus compromising the internal controls even though the committee is financially and accountancy literate. Originality/value This research distinguishes between accounting and nonaccounting financial experience in AC and shows that accounting experience significantly reduces internal control problems. In addition, it introduces CEO overconfidence as a moderating variable, which provides new insights into the field of corporate governance. The implications of these findings are far-reaching in enhancing transparency, trust and accountability by enhancing the quality of internal control.

Data breach notification laws and the cost of private debt

We examine the effect of state-level data breach disclosure mandates (DBN laws) on the cost of private debt. Using the staggered passage of DBN laws across the U.S. states, we document an increase in the cost of private debt for firms affected by these laws. These findings suggest that DBN laws increase lenders’ anticipation of cash flow risk from potential future costs related to data breach disclosures. We further document that the increase in the cost of private debt is more pronounced for firms that (i) belong to industries that are susceptible to data breaches, (ii) report internal control weaknesses, or (iii) disclose cyber security risks in their risk factor disclosures. Additionally, we find that the increase in the cost of private debt is less pronounced in firms that focus on cyber security measures, such as investing in cyber security or appointing a technology officer on their board. We contribute to the debt contracting and disclosure literature by focusing on the proactive response of private lenders after the passage of DBN laws to mitigate ex-ante the risk resulting from potential future data breach disclosures while also shedding light on the cost (financing cost) associated with mandatory disclosure practices.

Analisis Pengendalian Internal atas Siklus Pendapatan Valuta Asing (Studi Kasus pada PT X)

This study aims to analyze the internal control system applied to the foreign exchange revenue cycle by PT X. Weak internal control at PT X can lead to misappropriation by employees assigned to the sales, accounting, and/or cash functions. The study uses a qualitative case study approach. The researcher conducted interviews with internal staff related to the revenue cycle. Overall, the implementation of PT X's internal control can be said to be quite good, but still requires evaluation and improvement in aspects of risk monitoring, authorization of transaction evidence by related parties, and internal control over sales, accounting, and cash functions.

Digital tax enforcement and shadow banking of non-financial firms: Evidence from China's Golden Tax Project III

Digital tax enforcement (DTE) is an important external monitoring and governance mechanism for firms. We leverage the pilot of China's Golden Tax Project III as a natural experiment of DTE to investigate its impact on non-financial firms’ shadow banking. Using a sample of Chinese firms from 2007 to 2022, we document that DTE restrains shadow banking activities of non-financial firms by improving corporate transparency and mitigating agency problems. Additional analyses suggest that the effect is more salient for firms in regions with weak financial supervision, low-quality media monitoring, low-quality auditor, or weak internal control.

Bird-View Exploration of Internal Controls and Financial Performance of Selected Savings and Credit Co-Operative Societies in Moyo District, Uganda

This article explores internal controls and financial performance of selected savings and credit cooperative societies in Moyo district, Uganda. Utilizing both qualitative and quantitative methodologies, a descriptive cross-sectional research design was employed. The population consists of 56 participants. Data was collected with surveys and interviews. Findings revealed that internal controls are the pillar of any financial institution and SACCOs are not excluded and good financial performance is the motive for having good internal controls implemented in the SACCOs. In spite of the role played by internal controls, SACCOs have continued to face challenges relating to liquidity, profitability, efficiency; in terms of cost per borrower, and alleged malpractices. The above challenges could be attributed to weak internal control system, as this sets a base for misappropriation of organization’s resources. It is on this note that the study calls for the implementation of a systematic risk assessment process that identifies, assesses, and mitigates risks. Regularly update risk assessments to adapt to changing circumstances. More so, there is need to maintain effective internal control communication and proper flow of information down, across, and up within all sections of the organization. This includes clear communication of roles and responsibilities. Invest in continuous training and education for SACCO staff and members to ensure they have a strong understanding of internal controls, ethics, and risk management. Develop and regularly update comprehensive policies and procedures that clearly outline internal control processes, responsibilities, and expectations. This can serve as a guide for staff and members and ensure consistency in control activities. Keywords: Credits, Cooperative societies, Financial performance, Internal controls, Savings.

Evaluating Internal Control Mechanisms in Malaysian Public Sector Initiatives: Insights from the Public Accounts Committee (PAC) Reports

This study examines internal control challenges in Malaysian government projects, drawing on Public Accounts Committee (PAC) reports from 2019 to 2022. The focus on this period stems from the shift in PAC chairmanship from government to opposition, which enhanced perceived independence. However, the literature suggests that the PAC’s success depends more on collaborative decision-making than on the chairman’s political affiliation. Analyzing 29 government agencies across various sectors revealed recurring weaknesses in internal controls. The study employed the Committee of Sponsoring Organizations of the Treadway Commission’s (COSO) Internal Control-Integrated Framework (ICIF) to systematically identify these weaknesses. A content analysis method was used to examine the themes, which were grouped into five ICIF components: control environment, risk assessment, control activities, information and communication, and monitoring. Weaknesses in the control environment include conflicts of interest, compromised ethical values, inadequate governance, and a lack of accountability and transparency. Risk assessment deficiencies were found in financial risk management, procurement and acquisition risks, geopolitical and strategic risks, intellectual property and technology risks, and project management risks. Control activity weaknesses involved poor resource and process management, non-compliance, and flawed decision-making. Information and communication issues included poor documentation, inadequate system integration and data sharing, limited stakeholder engagement, weak communication protocols, and poor information management. Monitoring deficiencies were noted in regulatory compliance, contract management, financial oversight, monitoring systems, and disbursement tracking. Addressing these weaknesses in internal controls is crucial for minimizing the risks of fraud, waste, and loss of public trust

Internal Control Weakness and Corporate Divestitures

This study examines the influence of firms’ internal control weakness (ICW) reported under the Sarbanes-Oxley Act (SOX) on their subsequent divestiture decisions and the performance of these decisions. We argue that following ICW disclosure, firms are inclined to pursue corporate divestitures because such divestitures can reduce organizational complexity and help remedy firms’ ICW. We also propose that the positive influence of ICW disclosure on divestitures is stronger when a firm has recently appointed a CEO but weaker when there is a higher prevalence of ICW within the industry. Furthermore, we investigate the dual performance implications of divestitures following ICW disclosure. Although these divestitures, compared to divestitures not following ICW disclosure, are associated with higher stock market performance, they are also associated with slower sales growth for firms’ core businesses. We present empirical evidence that supports our arguments using a sample of S&P 1500 firms from 2003 to 2020. This study advances corporate strategy research by highlighting the role of ICW in shaping corporate divestiture decisions and documenting the multifaceted performance implications of such divestitures.

Supply chain digitalization and firms' green innovation: Evidence from a pilot program

Green innovation is essential for realizing environmental sustainability and achieving long-term ecological balance. This paper investigates the influence of supply chain digitalization on firms' green innovation in the manufacturing industry. China's 2018 Supply Chain Innovation and Application Pilot program as a quasi-natural experiment, we employ a difference-in-differences (DID) estimation approach to reach the following findings: (1) supply chain digitalization significantly enhances the quantity and quality of enterprise green innovation, with a more substantial impact on quality. (2) supply chain financing capacity and firm environmental awareness play a partial mediating role in the relationship supply chain digitalization and the quality and quantity of corporate green innovation. (3) the heterogeneity analysis reveals that the impact of supply chain digitalization on green innovation is notably heightened in firms with managers who have overseas experience, weak internal controls, and poor regional supply chain environments. This study enriches the theoretical understanding of enterprise green innovation from the perspective of supply chain digitalization, providing a theoretical basis and practical insights for green innovation practices in enterprises.

Aversion to the use of foreign exchange hedging in state-owned enterprises: Evidence from China

Using a sample of state-owned enterprises (SOEs) listed in China from 2006 to 2017, we examine the impact of state ownership on foreign exchange (forex) hedging. We find that SOEs engage in forex hedging both less frequently and to a lesser extent than non-SOEs. These results are robust to a series of additional tests, such as difference-in-differences analyses, instrumental variable tests, and alternative explanation tests. The effect is particularly pronounced for SOEs with weaker internal controls, fewer professional auditors, and less marketization. We further find that the use of currency derivatives by SOEs hinders the promotion of managers. Furthermore, the prevalence of subjective performance evaluation in SOEs, as opposed to objective performance measures, affects managers' decisions regarding hedging, as evidenced by negative promotion–performance sensitivity when using financial derivatives. Overall, our study sheds light on the aversion of SOEs to forex hedging, providing insight into the conservative decision-making tendencies of SOE managers under political governance.

Corporate Environmental, Social, and Governance (ESG) Performance and the Internal Control Environment

SYNOPSIS We consider how corporate environmental, social, and governance (ESG) performance relates to the strength of the internal control environment. The transparent reporting hypothesis predicts that high ESG performance signals ethical decision making and/or strong financial performance, both of which manifest in a stronger internal control environment and, therefore, fewer material weaknesses in internal controls. We find that ESG performance is negatively related to the likelihood of general internal control weaknesses, consistent with transparent reporting. We also find that ESG performance is negatively related to company-level internal control weaknesses, which are considered relatively severe. Further, we find that ESG performance is negatively associated with specific internal control weaknesses that indicate a lack of ethical tone at the top. We find support for both ethical and performance explanations behind the transparent reporting hypothesis. Overall, our results suggest that ESG performance is positively associated with the strength of the internal control environment. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M14; M40; M42.

Regional social trust and corporate environmental opportunistic disclosure: evidence from China

ABSTRACT In-depth research on social trust has revealed that it plays a crucial role in economic growth. Regional Social trust has a positive and significant effect on corporate financial information. It remains unknown whether regional social trust has the same effect on the environmental opportunistic disclosure (EOD). EOD is defined as soft information disclosure that is not quantifiable and verifiable. Our study analyzes whether regional social trust negatively affects EOD. Using data from A-share listed companies in China from 2016 to 2019, we find that regional social trust negatively affects EOD. This effect is particularly pronounced in areas with strong economic development, legal systems, and corporations with weak internal controls, strict external audits, and no punishment from environmental supervision. Regional social trust negatively impacts EOD with foreign direct investment as an intervening variable. After conducting robustness checks and an endogeneity test, our findings remain consistent. These findings validate the role of regional social trust in enhancing environmental information disclosure, which contributes to the information transparency of the capital market. Overall, it is essential to continue to improve the credit system and the regulation of environmental information disclosure.