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    The Effect of Human Resource Investment in Internal Control...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.03 Reporting Material Weaknesses 
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    Title:
    The Effect of Human Resource Investment in Internal Control on the Disclosure of Internal Control Weaknesses.
    Practical Implications:

    Using unique data on the number of IC personnel, this study provides direct empirical evidence on the link between IC personnel and ICWs, which has been only suggestive in the literature. Also, the findings in this study suggest that the information related to IC personnel could be useful for companies, as well as investors, to evaluate the quality of a firm’s internal controls over financial reporting.

    Citation:

    Choi, J. H., S. Choi, C. E. Hogan, and J. Lee. 2013. The Effect of Human Resource Investment in Internal Control on the Disclosure of Internal Control Weaknesses. Auditing: A Journal of Practice & Theory 32 (4): 169-199.

    Keywords:
    internal control personnel, internal control systems, internal control weakness, Sarbanes-Oxley Act
    Purpose of the Study:

    This study investigates the effect of human resource investment in internal control (IC) over financial reporting on the disclosure of internal control weaknesses (ICWs) at both the firm and the individual department level. The strength of a company’s internal control system depends on having sufficient personnel (hereafter, IC personnel) to carry out internal control functions. Having a sufficient number of personnel who are in charge of the internal control function ensures adequate segregation of duties, timely review, and monitoring of accounting functions, and may increase the depth and variety of accounting expertise, among other benefits. If companies are downsizing and eliminating employees with internal control responsibilities, control strength may be deteriorating at the same time fraud risk is increasing. As a result, internal control strength may deteriorate.

    It is important for companies and those charged with governance to understand the impact of investing in internal control personnel. While the authors expect internal control strength to be increasing in the level of investment in IC personnel, it is not clear whether the investment in IC personnel is positively or negatively related to the likelihood that a firm discloses an ICW. It is important to understand whether a higher level of investment in IC personnel is positively or negatively related to the likelihood of reporting ICWs, and whether changes in the level of IC personnel have any impact on changes in the likelihood of disclosing ICWs.

    Design/Method/ Approach:

    The authors hand-collect data on IC personnel and ICWs of Korean-listed firms for the period from 2005 to 2008. The financial data are collected from the KIS-Value database. The final sample sizes used for H1 and H2 are 5,402 and 176 firm-year observations, respectively. The average size of sample firms (LNTA) is 25.33, which is equivalent to 101 billion Korean Won ($84 million).

    Findings:
    • Investment in IC personnel is associated with the strength of internal control systems.
    • Firms with a greater investment in IC personnel are less likely to report material weaknesses in internal controls.
    • At the department level, the ratio of IC personnel (both the raw ratio and industry- and year-mean-adjusted ratio) working in the finance department out of the total number of employees of the firm is negatively associated with the disclosure of ICWs.
    • Changes in IC personnel are strongly related to the likelihood of disclosing ICWs. For example, if a firm reduces (increases) IC personnel during the year, the firm is more (less) likely to disclose an ICW at the end of the year.
    • Changes in IC personnel are related to the likelihood that firms remediate the ICW.
    • The disclosures of both personnel-related ICWs and non-personnel-related ICWs are weakly related to the ratio of, or the change in the ratio of, IC personnel. These findings are particularly important because they show that the investment in IC personnel can even affect non-personnel-related ICWs.
    • The quality of IC personnel is associated with the likelihood of disclosing ICWs and remediating previously disclosed ICWs, in addition to the quantity of the IC personnel, even though the data on quality are noisy.
    Category:
    Internal Control
    Sub-category:
    Reporting Material Weaknesses