Does Ineffective Internal Control over Financial Reporting Affect a Firm’s Operations? Evidence from Firms’ Inventory Management

49 Pages Posted: 10 Dec 2012 Last revised: 2 Aug 2014

See all articles by Mei Feng

Mei Feng

University of Pittsburgh - Katz Graduate School of Business

Chan Li

University of Kansas

Sarah E. McVay

University of Washington

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis

Date Written: August 1, 2014

Abstract

We investigate whether ineffective internal control over financial reporting has implications for firm operations by examining the association between inventory-related material weaknesses in internal control over financial reporting and firms’ inventory management. We find that firms with inventory-related material weaknesses have systematically lower inventory turnover ratios and are more likely to report inventory impairments relative to firms with effective internal control over financial reporting. We also find that inventory turnover rates increase for firms that remediate material weaknesses related to inventory tracking. Remediating firms also experience increases in sales, gross profit and operating cash flows. Finally, we assess the generalizability of our findings by examining all material weaknesses in internal control over financial reporting, regardless of type, and provide evidence that firms’ return-on-assets are associated with both their existence and remediation. Collectively, our findings support the general hypothesis that internal control over financial reporting has an economically significant effect on firm operations.

Keywords: Internal Control, Inventory Management, Firm Operations

JEL Classification: M41

Suggested Citation

Feng, Mei and Li, Chan and McVay, Sarah E. and Skaife, Hollis Ashbaugh, Does Ineffective Internal Control over Financial Reporting Affect a Firm’s Operations? Evidence from Firms’ Inventory Management (August 1, 2014). Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2187599 or http://dx.doi.org/10.2139/ssrn.2187599

Mei Feng

University of Pittsburgh - Katz Graduate School of Business ( email )

Pittsburgh, PA 15260
United States

Chan Li

University of Kansas ( email )

Capitol Federal Hall
Lawrence, KS 66045
United States
7857661277 (Phone)
66045 (Fax)

Sarah E. McVay (Contact Author)

University of Washington ( email )

Box 353200
Seattle, WA 98195-3200
United States

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis ( email )

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

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