Venture Capital and Material Weaknesses in Internal Control

Abstract

In this paper, we investigate the association between venture capital (VC) backing and the quality of internal controls. We find that companies with VC backing have fewer material weaknesses in internal control. Moreover, the effect of VC backing is more pronounced for entity-level material weaknesses than for account-level material weaknesses. We also find that material weakness disclosures are more informative if they are disclosed by companies backed by venture capitalists (VCs). Specifically, material weaknesses are more likely to be followed by subsequent financial statement restatements for VC-backed companies than for other companies. Finally, companies backed by more reputable VCs are less likely to receive negative internal control opinions from management or from their external auditors.

Keywords: Venture Capital, Initial Public Offerings, Corporate Governance, Material Weaknesses in Internal Control, Sarbanes-Oxley Act (SOX)

JEL Classification: D01, G24, G34, K4