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Internal Control Over Financial Reporting and Managerial Rent Extraction: Evidence from the Profitability of Insider Trading

50 Pages Posted: 16 Sep 2011 Last revised: 3 Mar 2013

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis

David Veenman

University of Amsterdam - Amsterdam Business School (ABS)

Daniel Wangerin

Michigan State University

Abstract

This paper examines the association between ineffective internal control over financial reporting and the profitability of insider trading. We predict and find that the profitability of insider trading is significantly greater in firms disclosing material weaknesses in internal control relative to firms with effective control. The positive association is present in the years leading up to the disclosure of material weaknesses, but disappears after remediation of the internal control problems. We find insider trading profitability is even greater when insiders are more likely to act in their own self-interest as indicated by auditors’ weak “tone at the top” adverse internal control opinions and this incremental profitability is driven by insider selling. Our research identifies a new setting where shareholders are most at risk for wealth transfers via insider trading and highlights market consequences of weak “tone at the top”.

Keywords: Insider trading, SOX 404, Internal control, Tone at the top, Management integrity, Management turnover

JEL Classification: D82, G14, G34, G38, M41

Suggested Citation

Skaife, Hollis Ashbaugh and Veenman, David and Wangerin, Daniel, Internal Control Over Financial Reporting and Managerial Rent Extraction: Evidence from the Profitability of Insider Trading. Journal of Accounting & Economics (JAE), Volume 55, Issue 1, February 2013, Pages 91–110. Available at SSRN: https://ssrn.com/abstract=1928557 or http://dx.doi.org/10.2139/ssrn.1928557

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis ( email )

Graduate School of Management
1 Shields Ave
Davis, CA 95616
United States

David Veenman (Contact Author)

University of Amsterdam - Amsterdam Business School (ABS) ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

Daniel D. Wangerin

Michigan State University ( email )

270 North Business Complex
East Lansing, MI 48824-1034
United States

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