Business Strategy and Internal Control Over Financial Reporting
46 Pages Posted: 31 Jul 2015 Last revised: 2 Aug 2017
Date Written: August 16, 2016
This study examines whether a company’s business strategy is an underlying determinant of the strength of its internal control over financial reporting (ICFR) and the quality of auditors’ attestation reports concerning ICFR. Organizational theory suggests that companies following an innovative “prospector” strategy are likely to have weaker internal controls than companies following an efficient “defender” strategy. Consistent with theory, we find that firms with greater prospector-like characteristics are more likely to report and less likely to remediate material weaknesses, incremental to known determinants of material weaknesses. We also find that auditors’ internal control reporting quality is lower among clients with greater prospector-like characteristics when measured using the timeliness of reported material weaknesses. Our findings indicate that business strategy is a useful summary indicator for evaluating companies’ internal control strength and suggest that internal control reporting is an important area for audit quality improvement among prospector-like clients.
Keywords: business strategy, internal control, material weakness, Sarbanes-Oxley, Auditing Standard No. 5
JEL Classification: D21, L21, M41
Suggested Citation: Suggested Citation