Internal Control Material Weakness, Analysts' Accuracy and Bias, And Brokerage Reputation

54 Pages Posted: 14 May 2007 Last revised: 7 Mar 2015

See all articles by Li Xu

Li Xu

Washington State University, Vancouver

Alex P. Tang

Morgan State University

Date Written: March, 2008

Abstract

Using a sample of firms that disclose internal control material weaknesses under Sections 302 and 404 of the Sarbanes-Oxley Act, we investigate the relations between the accuracy and bias of financial analysts' earnings forecasts and disclosed internal control material weaknesses. We find that forecast accuracy is negatively related to material weaknesses in internal control when disclosed internal control material weaknesses are related to controls over firms' broader control environment (firm-level internal control). We also hypothesize and find that optimistic forecast bias is higher for firms disclosing firm-level internal control material weaknesses, suggesting that, due to the increased complexity related to inefficient internal control at firm-level, analysts intentionally bias their forecasts upward to gain favorable access to firms' internal information. In addition, we find that the optimistic bias only exists in forecasts issued by analysts who are affiliated with less reputable brokerage houses.

Keywords: Internal control material weakness, financial analysts, earnings forecast accuracy, earnings forecast bias, Sarbanes-Oxley Act

JEL Classification: M41, G34, G29, G38

Suggested Citation

Xu, Li and Tang, Alex P., Internal Control Material Weakness, Analysts' Accuracy and Bias, And Brokerage Reputation (March, 2008). Available at SSRN: https://ssrn.com/abstract=982216 or http://dx.doi.org/10.2139/ssrn.982216

Li Xu (Contact Author)

Washington State University, Vancouver ( email )

14204 NE Salmon Creek Avenue
Vancouver, WA WA 98686-9600
United States

Alex P. Tang

Morgan State University ( email )

1700 E. Cold Spring Ln
Baltimore, MD 21251
United States

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