How does Disclosure of Internal Control Quality Affect Management's Choice of that Quality

49 Pages Posted: 10 Jan 2006  

Ping Zhang

University of Toronto - Rotman School of Management

J. Efrim Boritz

University of Waterloo - School of Accounting and Finance

Date Written: April 5, 2006

Abstract

We utilize a single period model to investigate the tradeoffs that management might make when faced with the necessity of disclosing the quality of the internal control over financial reporting (henceforth ICOFR) and the outcomes that would result from such tradeoffs.

Our analysis indicates that requiring reporting on internal control effectiveness can lead to higher control quality if management's performance-related compensation is dominated by stock options. However, if management's performance-related compensation is mainly in the form of cash bonuses, then the required disclosure leads to lower control quality. Attempts by management to bias reported information can reduce internal control quality when internal control quality is not disclosed, but have no impact on control quality when internal control is disclosed.

Keywords: Internal control quality, internal control disclosure, management's compensation

JEL Classification: M4

Suggested Citation

Zhang, Ping and Boritz, J. Efrim, How does Disclosure of Internal Control Quality Affect Management's Choice of that Quality (April 5, 2006). CAAA 2006 Annual Conference Paper; Rotman School of Management Working Paper No. 07-09. Available at SSRN: https://ssrn.com/abstract=874890 or http://dx.doi.org/10.2139/ssrn.874890

Ping Zhang (Contact Author)

University of Toronto - Rotman School of Management ( email )

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

Efrim Boritz

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada
519-888-4567 (Phone)
519-888-7562 (Fax)

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