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Internal Control Weaknesses and Information Precision

Internal Control Weaknesses and Information Precision. Zi-Chin Weng Chen-Lung Chin. Be Veg , Go Green , 2 Save Planet. Introduction. Section 404 of the SOX Act requires Management to report the effectiveness of Internal Controls Auditor to attest the validity of these reports

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Internal Control Weaknesses and Information Precision

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  1. Internal Control Weaknesses and Information Precision Zi-Chin Weng Chen-Lung Chin Be Veg, Go Green, 2Save Planet

  2. Introduction • Section 404 of the SOX Act requires • Management to report the effectiveness of Internal Controls • Auditor to attest the validity of these reports • Cons and pros: cost/benefit trade-off • Regulators: • higher quality financial reporting/ lower cost of capital • Firms: • cost exceeds their perceived benefits. • Empirical evidence: • Mixed: • Accrual quality: Doyle et al. (2007); Ashbaugh-Skaife et al. (2008). • Cost of capital: Ogneva et al. (2007); Ashbaugh-Skaife et al. (2008).

  3. Introduction • The objective • Directly examines the information production process in ICW setting. • Overall information environment • Public (idiosyncratic) information • Private (common) information Be Veg, Go Green, 2Save Planet

  4. Introduction • The purposes of this paper • The relation between internal control weakness(ICW) and information precision. • Public information precision • Private information precision • Relative effects of degree of ICWseverity on • the precisions of public and private information. • Whether remediation of previously ICW • Enhances the precisions of public and private information.

  5. Research structure Public information precision Information environment ICW Private information precision Be Veg, Go Green, 2Save Planet

  6. Contributions Be Veg, Go Green, 2Save Planet • IC quality is a critical determinant of information precision. • provide evidence that ICW leads to reduced quality of overall information environment as well as public and private information precisions. • Public and private information precisions are complementary effect.

  7. Literature and hypothesis • The impact of ICW on information precision • Inf. market participant use is provided by firms • ICW firms introduce misstatements into the F/S and exhibits greater information noise • Earnings quality↓ (Ashbaugh-Skaife et al., 2008) • Analysts’ forecasts dispersion ↑ (Kim et al.,2008) • Market return (Hammersley et al. 2007) • More accurate analyst earnings forecasts (Hope, 2003a) • Lower cost of capital and information asymmetry (Ramnath et al., 2008) H1a: ICW is negatively related to public information precision.

  8. Literature and hypothesis • Information environment is comprised of • Private / public information • Two opposite perspectives • Substitute perspective (Verrecchia 1982) • Higher public info. precision reduces market participants' incentives to generate more precise private information. • Complementary perspective (McNichols and Trueman, 1994) • A public release of information=> analysts with diverse information-processing new private skills to generate information Private (Substitute) (+) => ICWPublic information precision Private (Complementary)(-) H1b: ICW is associated with the private information precision.

  9. Literature and hypothesis Be Veg, Go Green, 2Save Planet • The severity of ICW and information precision • The ICW severity varies substantially within the material weakness classification (Moody’s, 2006) • Account-specific weaknesses • Firm-level weaknesses • ICW firms with firm-level weaknesses • have lower accruals quality relative to ICW firms with account-specific weaknesses (Doyle et al. 2007). H2: Firm-level ICW have a stronger association with information precision than account-specific ICW.

  10. Remediation of ICW • The effect of remediation of ICW firms • Remediation firms exhibit significant improvements • Accrual quality (Ashbaugh-Skaife et al. 2008 ) • The quality of new CFO (Li et al. 2007) H3a: Remediation firms exhibit an increase in public information precision relative to non-remediation firms. • There are two opposite perspectives about the relation between public and private information precisions • substitute and complementary effects H3b:Remediation firms exhibit an association with private information precision relative to non-remediation firms.

  11. Research Design and Data Sources Be Veg, Go Green, 2Save Planet • The impact of ICW on information precision • Test H1a and H1b • ICW =1 if firms has ICW (+)

  12. Research Design • Following Barron (1998) • RPUBIIC=fractional rank of public information precision (Barron et al.1998; Botosan et al.2004 ) • RPRIVATE=fractional rank of private information precision (Barron et al.. 1998; Botosan et al.2004 ) • SE=expected square error in the mean forecast • D=expected forecast dispersion • N= the number of forecasts Be Veg, Go Green, 2Save Planet

  13. Research Design Be Veg, Go Green, 2Save Planet • H2: The impact of ICW severity on information precision WHERE ICW_acc = 1 if the firm discloses account-specific ICW, and 0 otherwise. ICW_firm = 1 if the firm discloses firm-level ICW, and 0 otherwise. H2: a1 > a2

  14. Research Design • H3: The impact of ICW firms with remediation Independent variables Weakness = 1 if the firm received an adverse SOX 404 opinion in the current or prior year, and zero otherwise. Remediation= 1 if the firms received an adverse SOX 404 opinion in the current year, but received an unqualified SOX 404 opinion in successive years. H3:m2 > 0, n2 > 0.

  15. Sample Be Veg, Go Green, 2Save Planet • Sample period: 2004 to 2007. • Data requirements • accelerated filers in the U.S. • Financial statement data are available from I/B/E/S, Audit Analytics , COMPUSTAT North America • The severity of ICW • 10-Ks in the EDGAR from November 2004 to December 2007

  16. Empirical results Descriptive statistics

  17. Average rank portfolio

  18. Be Veg, Go Green, 2Save Planet Pearson correlation matrix

  19. Table 5_Test H1

  20. Further analysis • The impact of ICW on overall information environment • Model: • Overall information uncertainty (UNCER) is defined as follows (Barron et al., 1998): • UNCER = fractional rank of uncertainty for firm i, year t. Uncertainty is drawn from Barron et al. (1998) and can be defined as follows:

  21. Be Veg, Go Green, 2Save Planet Table 6_The impact of ICW on overall information environment

  22. Table 7_Test H2

  23. Table 8_Test H3

  24. Sensitivity Analyses (1) • Controlling the endogeneity effect (Doyle et al. (2007a; Ashbaugh-Skaife et al. (2007). • Two stage treatment effect model. • First: ICW=δ0+δ1Market+δ2 others+ε • Second: equation (1) or (2) • Panel A of Table 9: Robust! Be Veg, Go Green, 2Save Planet

  25. Controlling the endogeneity effect

  26. Sensitivity Analyses (2) • Change model, not level model • Contemporary relation (cause-effect) • Overcome omitted variables • Model • Improve=1 if firm remediate this year (+) • △= change • Panel A of Table 9: Robust ! Be Veg, Go Green, 2Save Planet

  27. The results of change sample

  28. Be Veg, Go Green, 2Save Planet Internal control weakness counts

  29. Conclusions Be Veg, Go Green, 2Save Planet • ICW firms have • less precise public and private information and • lower level of overall information environment relative to non-ICW firms. • Public information precision is lower for firms with firm-level ICW than account-specific ICW. • ICW firms with remediation in following year will • increase information precision relative to ICW firms without remediation.

  30. 事务所行业专长、市场化程度对于自愿性内部控制鉴证报告披露的影响事务所行业专长、市场化程度对于自愿性内部控制鉴证报告披露的影响 Be Veg, Go Green, 2Save Planet

  31. Introduction • 中国财政部等五部门于2008年发布《企业内部控制基本规范》 • 要求上市公司披 • 露关于企业内部控制报告及 • 审计师对其进行鉴证。 • 執法上並未強制 • Us: mandatory • China: voluntary Be Veg, Go Green, 2Save Planet

  32. Introduction • H1：事务所行业专长对于自愿性内部控制鉴证报告的披露正相关。 • Signaling • Auditor quality: Datar et al. (1991) • Auditors’ expertise: (Balsam, 2003) • Auditor specialists Be Veg, Go Green, 2Save Planet

  33. Research Design • H2：在市场化程度高的地区注册的公司，更有可能提供内部控制鉴证报告。 • 整体的政治、法律与经济机制(为市场化程度)会影响 • 公司行为/该地区的财务报导与会计质量(Ball, et al., 2000)， • 会计师的选择(Wang et al, 2008)。 • 市场化程度高=>竞争激烈=>从而迫使管理层通过加强内部控制建设以适应激烈的市场化竞争的需要。 Be Veg, Go Green, 2Save Planet

  34. Introduction • 事务所行业专长（AS）: AS= • 分子:事务所i在特定行业k的客户营业总收入， • 分母:代表K行业中全部客户营业总收入 • 市场化程度 • 中国市场化指数——各地区市场化相对进程2006年度报告(樊纲、王小鲁、朱恒鹏，2007) • Model Probit (AS=1) = a0 + a1 (AS) + a2 control. (+) Be Veg, Go Green, 2Save Planet

  35. http://www.flickr.com/photos/annahsu/3541669178 • 最新研究：Livestock's Long Shadow51%的溫室氣體排放來自LIVESTOCK • The fast and efficient solution: • 2007年諾貝爾獎得主「聯合國氣候變遷小組」主席帕喬里表示： 「Don't eat meat, ride a bike, and be a frugal shopper -- that's how you can help brake global warming」

  36. Be Veg, Go Green, Save the Planet吃素，環保，救地球

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