Internal control weaknesses, corporate governance and the informativeness of earnings

Abstract

In this study I examine whether market discounts the information content of accounting earnings for firms reporting material weaknesses under Section 404 of SOX. To explore the influence of managerial ownership, I examine whether managerial ownership moderates the negative consequences of material weakness disclosures and whether its impact depends on the magnitude of information asymmetry. To explore the influence of female executives, I examine whether the presence of female executives moderates the negative consequences of material weakness disclosures and whether its impact depends on the magnitude of information asymmetry. Because the macroeconomic environment changes after the financial crisis, I focus on the sample period from 2004 to 2007, and a sample of 2,349 firm-year observations yields the following results. First, regardless of the moderating effects of managerial ownership or female exeutives, the results do not indicate a significantly negative impact of material weakness disclosures under Section 404 of SOX on the informativeness of earnings. Second, consistent with the argument that managerial ownership reduces agency costs, I find that managerial ownership moderates the negative impact of material weaknesses on the informativeness of earnings. Third, because the magnitude of information asymmetry decreases with firm age, I find that the moderating effect of managerial ownership diminishes with firm age. Fourth, consistent with the argument that female executives are more risk-averse and therefore ensure the quality of accounting earnings, I find that the presence of female executives moderates the negative impact of material weaknesses on the informativeness of earnings. Fifth, I find that the moderating effect of female executives also diminishes with firm age. These results are robust to a number of additional tests.