Investor Confidence in Earnings: The Interactive Effects of Internal Control Audits and Manager Legal Liability
Posted: 4 Feb 2011 Last revised: 24 Feb 2011
Date Written: January 31, 2011
An underlying objective of the Sarbanes-Oxley Act is to provide investors with reliable information, which presumably should increases investor confidence in financial disclosures. In part to achieve this goal, managers now have personal legal liability for internal control over financial reporting as well as undergo mandated internal control audits (IC Audits). The fundamental assumption is that these two mechanisms produce either additive or synergistic effects on investor behavior. However, this assumption contradicts agency theory, which suggests a pattern of interaction in which each mechanism alone is sufficient. The current study informs this debate by investigating the possible interactive effects of manager liability and IC Audits on investor confidence and its antecedents including managers’ ICFR disclosures. Results of a laboratory experiment suggest that only the IC Audit improves the accuracy of managers’ ICFR disclosures while investor behavior tracks agency theory predictions rather than the assumptions underlying the current regulatory environment.
Keywords: internal control audits, legal liability, investor confidence, stock price reaction
JEL Classification: M42, G18
Suggested Citation: Suggested Citation