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    Board Independence and Internal Control Weakness: Evidence...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 01.04 Impact of 404, 07.03 Reporting Material Weaknesses, 13.01 Board/Audit Committee Composition 
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    Title:
    Board Independence and Internal Control Weakness: Evidence from SOX 404 Disclosures
    Practical Implications:

    This study examines the effects on internal control weaknesses associated with an independent board of directors. A benefit of having an independent board is the timely remediation of ICWs. This is of high importance because the quicker a material weakness is resolved, the sooner a company can return to normal operations. Another contribution of this study is the discovery of implications regarding Auditing Standard No. 5. The standard changed internal control evaluation to become more holistic and less detailed. This provides the board of directors less tangible information on the status of internal controls.

    Citation:

    Chen, Yangyang, Robert. W. Kechel., V. B. Marisetty, C. Truong, and M. Veeraraghavan.2017. Board Independence and Internal Control Weakness: Evidence from SOX 404 Disclosures. Auditing, A Journal of Practice and Theory 36(21): 45-62.

    Keywords:
    internal control weakness; board independence; unitary versus dual leadership; SOX 404
    Purpose of the Study:

    An important role of corporate governance is its duty to manage various aspects of risk. One way to accomplish this goal is through oversight of management’s system of internal controls. This study examines how corporate governance structure affects management’s disclosure of material weaknesses in internal control over financial reporting. Specifically, the authors investigate how the board’s characteristics of independence and leadership style (a unitary leader versus separate CEO and chairman) influence the frequency of internal control weaknesses (ICWs) reported, the types of ICWs reported, and timeliness of ICW remediation. 

    Design/Method/ Approach:

    Reported ICWs were gathered from Audit Analytics, based on forms 10-K, 10-K/A, 20-F, and 40-F. Board demographics, including independence variables, were gathered from RiskMetrics. The final sample consisted of 2,048 firms and 11,226 observations, from 2004 – 2012.

    Findings:

    The authors find the following related to board independence:

    • Board independence is negatively associated with the disclosure of ICWs. The evidence suggests that higher board independence causes a lower probability of ICWs occurring.
    • There was lower number of both account-specific and company-level ICWs in boards with more independent directors.
    • Board independence is associated with timely remediation of ICWs.

     

    The authors also find:

    • The negative relation between board independence and ICWs is strongest in a company that has unitary leadership. This demonstrates that an effective board is based more on board independence rather than board leadership style.
    • The implementation of Auditing Standard No. 5 in 2007 somewhat weakened the effect of board independence on the disclosure of ICW’s.
    Category:
    Governance, Internal Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Board/Audit Committee Composition, Impact of 404, Reporting Material Weaknesses
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary