Accounting Manipulation, Peer Pressure, and Internal Control
39 Pages Posted: 25 Apr 2016 Last revised: 30 May 2017
Date Written: April 20, 2016
We study firms' investment in internal control to reduce accounting manipulation. We first show the peer pressure for manipulation: one manager manipulates more if he suspects reports of peer firms are more likely to be manipulated. As a result, one firm's investment in internal control has a positive externality on peer firms. It reduces its own manager's manipulation, which in turn mitigates the manipulation pressure on managers in peer firms. Firms don't internalize this positive externality and thus under-invest in their internal control over financial reporting. The under-investment problem provides one justification for regulatory intervention in firms' internal control choices.
Keywords: accounting manipulation, peer pressure, internal control, SOX
JEL Classification: G18, M41, M48, K22
Suggested Citation: Suggested Citation