Internal Control Over Financial Reporting and Managerial Rent Extraction: Evidence from the Profitability of Insider Trading
Hollis Ashbaugh Skaife
Graduate School of Management, UC-Davis; University of Wisconsin, Madison - Department of Accounting and Information Systems
Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)
Michigan State University
Journal of Accounting & Economics (JAE), Volume 55, Issue 1, February 2013, Pages 91–110
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”.
Number of Pages in PDF File: 50
Keywords: Insider trading, SOX 404, Internal control, Tone at the top, Management integrity, Management turnover
JEL Classification: D82, G14, G34, G38, M41Accepted Paper Series
Date posted: September 16, 2011 ; Last revised: March 3, 2013
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