An Empirical Analysis on the Relations among the Qualitative Characteristics of Internal Control over Financial Reporting, Earnings Management, and Value Relevance
Asian Tax Journal Vol. 10 No. 4 (2009), pp. 117-150
Abstract
The study examines empirically on the qualitative characteristics of the internal accounting control system and its attestation report of the external auditor required by the standard internal accounting control system, which is recently introduced as a part of a broader internal management control system designed to emphasize management's responsibility over financial reporting. Based on the assumption that internal accounting control system is an instrument of ensuring transparency of accounting information disclosure, this study attempts to show empirically how corporate value is affected by the reporting of material weaknesses of the internal accounting control system, which are the qualitative characteristics of internal control over financial reporting. In addition, this study shows how affected by disclosure of the qualitative characteristics of internal control over financial reporting on the results of the financial and non‐financial variables, which are the economic characteristics of corporations. Specifically, we defined the public notification of material weaknesses in the review report of internal control over financial reporting as the qualitative characteristics of internal control over financial reporting. We examined through Logit analysis how different earnings management was between companies reported material weaknesses and companies announced the review opinion of internal control over financial reporting. In addition, the relations between earnings management and corporate value was examined through multi－variate regression analysis. The relations between the qualitative characteristics of internal control over financial reporting and corporate value was tested through 2SLS model after earnings management was controlled. The sample of this study was 109 firms in the experimental group that had announced opinions on material weaknesses in the review opinions of internal control over financial reporting in their external audit reports in 2005～2007, and 109 firms in the control group of 218 firms. The results of this study are summarized as follows：First, with regard to the correlation between the qualitative characteristics of internal control over financial reporting and earnings management, the tendency of earnings management was lower in firms that reported the qualitative characteristics of internal control over financial reporting. Second, with regard to dependent variable external cumulative average residual (CAR), the degree of earnings management showed a significant negative correlation, suggesting that firms with a high corporate value was less likely to do earnings management. Third, the influence of CAR with the qualitative characteristics of internal control over financial reporting was insignificant but showed marginally significant. This means that the increase in corporate value is correlated with the public notification of opinions on material weaknesses in the external audit reports, which are qualitative characteristics of internal control over financial reporting. The contribution of this study may be summarized as follows：First, it has attempted to expand a research direction to study on the relations of corporate value with earnings management in the context of internal accounting control system that has been recently introduced to emphasize the management responsibility over the quality of the system. Second, from the corporate perspective, transparent disclosure on quality of internal accounting control system is a critical factor for corporate value providing more credible information to the accounting information users or investors. Therefore, it is expected that the evidence above can be used as a means to discourage manipulating earnings and to enhance the credibility and usefulness of financial reports for investors’ decision making by transparent information of internal control over financial reporting.
Keywords
- Internal control system
- Internal control over financial reporting
- Accounting transparency
- Value relevance
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