lnternal Control Weaknesses and Accounting Conservation:Evidence from the post Created by Mitra Santanu

This study examines the relationship between accounting conservatism and internal control weaknesses (ICW) in the post–Sarbanes–Oxley Act of 2002 (SOX) period when the U.S. firms have been subject to higher regulations and enhanced corporate oversight and scrutiny. Our multivariate analyses show that the firms having ICW, especially the firms with company-level ICW, have significantly changed their conservative reporting practice from the pre- to the post-SOX period. The analyses further show that the ICW firms exhibit greater accounting conservatism in the post-SOX period compared with the firms with effective internal controls (non-ICW). The result is mostly driven by increased conditional conservatism by the firms having company-level ICW that are more pervasive in effect, less auditable, and more difficult to detect and prevent. Furthermore, we find that the difference in conservatism between ICW and non-ICW firms is more prominent in the first 3 post-SOX years than in the last 3 post-SOX years of the sample period. These findings suggest that enhanced corporate oversight and scrutiny have induced the ICW firms to use more accounting conservatism in an effort to reduce reporting uncertainty, enhance information reliability, and promote contracting efficiency. Our findings are consistent with prior studies that demonstrate a shift in the U.S. firms’ financial reporting strategies in response to stringent regulations and governance in the post-SOX period.