The Implications of Ineffective Internal Control and SOX 404 Reporting for Financial Analysts

54 Pages Posted: 20 Apr 2013 Last revised: 14 May 2013

See all articles by Sarah B. Clinton

Sarah B. Clinton

University of Tennessee, Knoxville - College of Business Administration

Arianna S. Pinello

Florida Gulf Coast University

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis

Date Written: January 2013

Abstract

The mandatory reporting of firms’ internal control effectiveness continues to be debated by equity market participants, U.S. regulatory agencies and oversight committees. We investigate the implications of material weaknesses in internal control and SOX 404 required reporting of such for financial analysts because analysts are important intermediaries in the U.S. capital market and it is not known whether analysts’ forecasts or coverage decisions are affected by firms’ internal control problems or reporting, respectively. Results of our empirical tests indicate that analysts provide less accurate forecasts and there is greater forecast dispersion for firms with ineffective internal control. We also find that firms that disclose internal control problems have less analyst coverage and that analyst following declines after the material weakness in internal control is disclosed. The results are robust to controlling for potential self-selection bias and management earnings guidance. Our study documents the consequences of ineffective internal control for an important class of financial statement users and suggests the required reporting on the effectiveness of internal control is beneficial to understanding the properties of analysts’ forecasts.

Keywords: analysts, earnings forecasts, analyst following, internal control, SOX 404

JEL Classification: K22, M41, M43, M49

Suggested Citation

Clinton, Sarah B. and Pinello, Arianna S. and Skaife, Hollis Ashbaugh, The Implications of Ineffective Internal Control and SOX 404 Reporting for Financial Analysts (January 2013). Journal of Accounting and Public Policy, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2253552 or http://dx.doi.org/10.2139/ssrn.2253552

Sarah B. Clinton (Contact Author)

University of Tennessee, Knoxville - College of Business Administration ( email )

453 Haslam Business Building
Knoxville, TN 37996
United States

Arianna S. Pinello

Florida Gulf Coast University ( email )

10485 FGCU Blvd S
Ft. Myers, FL 33965-6565
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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