Does Intense Scrutiny over Financial Reporting Controls Impact Operational Outcomes?

54 Pages Posted: 17 Apr 2023

See all articles by Andrea K. Down

Andrea K. Down

University of Toronto - Rotman School of Management

Joseph H. Schroeder

Indiana University - Kelley School of Business - Department of Accounting

Marcy L. Shepardson

Indiana University - Kelley School of Business - Department of Accounting

Date Written: April 2023

Abstract

In this study, we examine how intense scrutiny over financial reporting controls affects operating control outcomes. Increasing emphasis on internal controls over financial reporting (ICFR) might require firms to modify resource allocations within control systems, such that the quality of operating controls could improve or deteriorate. Using a sample of firms subject to FDA inspections, we find that introducing intense scrutiny leads to improvements in operating controls, as evidenced by lower probabilities of regulatory deficiencies. Resource availability helps firms enhance the observed benefits, while resource constraints force firms to focus on financial reporting controls, at the expense of their regulatory compliance. Our results suggest that intensified ICFR scrutiny facilitates a complementary relationship between financial reporting and operating controls: firms implement system-wide changes that advance both functions. Identifying this positive externality is important because many stakeholders question whether the benefits of the increased ICFR focus introduced by the Sarbanes-Oxley Act (SOX) outweigh the costs.

Suggested Citation

Down, Andrea K. and Schroeder, Joseph H. and Shepardson, Marcy L., Does Intense Scrutiny over Financial Reporting Controls Impact Operational Outcomes? (April 2023). Rotman School of Management Working Paper No. 4411079, Available at SSRN: https://ssrn.com/abstract=4411079 or http://dx.doi.org/10.2139/ssrn.4411079

Andrea K. Down

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Joseph H. Schroeder (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Marcy L. Shepardson

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

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