The effect of internal control environment on the value relevance of earnings
-
DOIhttp://dx.doi.org/10.21511/imfi.16(2).2019.16
-
Article InfoVolume 16 2019, Issue #2, pp. 182-194
- 1478 Views
-
241 Downloads
This work is licensed under a
Creative Commons Attribution 4.0 International License
This study examines whether a suitable control environment increases the value relevance of earnings by providing greater assurance on the reliability of financial reporting. Specifically, the level of suitable control environment is assessed by considering the quantity and quality of IC personnel, which are closely related to the personnel integrity/ethical values, competence, and authority/responsibility. Using a sample of 1,834 firm-year observations of Korean listed companies covering 2005–2010, the author finds that earnings are more value relevant when the increase in the average work experience of IC personnel is greater. However, no evidence is found that the value relevance of earnings is positively associated with the increase in the proportion of IC personnel. The findings suggest that a suitable control environment, established by deployment of qualified IC personnel with more work experience, improves the IC effectiveness and, thus, provides greater assurance on the reliability of financial reporting to market investors.
- Keywords
-
JEL Classification (Paper profile tab)M41, O15, G32
-
References32
-
Tables7
-
Figures0
-
- Table 1. Sample selection procedure
- Table 2. Descriptive statistics of variables
- Table 3. Correlations of variables
- Table 4. Analysis on the value relevance of earnings for subgroups
- Table 5. Analysis on the Effect of IC Environment on the Value Relevance of Earnings
- Table 6. Analysis on the effect of IC environment on the value relevance of earnings after controlling for the effect of the quantity and quality of IC personnel on each other
- Table 7. Additional Analysis on the Effect of IC Environment on the Value Relevance of Earnings using Modified Variables
-
- Ashbaugh-Shaife, H., Collins, D., Kinney, W., & Lafond, R. (2008). The effect of SOX internal control deficiencies and their remediation on accrual quality. The Accounting Review, 83(1), 217-250.
- Ashbaugh-Shaife, H., Collins, D., Kinney, W., & Lafond, R. (2009). The effect of SOX internal control deficiencies on firm risk and cost of equity. Journal of Accounting Research, 47(1), 1-43.
- Baron, M., & Kenny, A. (1986). The moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations. Journal of Personality and Social Psychology, 51(6), 1173-1182.
- Barth, M., Beaver, W., & Landsman, W. (2001). The relevance of the value relevance literature for financial accounting standard setting: another view. Journal of Accounting and Economics, 31(1-3), 77-104.
- Beaver, W. (1998). Financial Reporting: An Accounting Revolution. NJ: Prentice-Hall, Englewood Cliffs. 6. Beneish, M. D., Billings, M., & Hodder, L. (2008). Internal control weaknesses and information uncertainty. The Accounting Review, 83(3), 665-703.
- Chan, K., Farrell, B., & Lee, P. (2008). Earnings management of firm reporting material internal control weaknesses under section 404 of the Sarbanes-Oxley Act. A Journal of Practice & Theory, 27(2), 161-179.
- Choe, H., Kho, B. C., & Stultz, R. M. (1999). Do foreign investors destabilize stock markets? The Korean experience in 1997. Journal of Financial Economics, 54(2), 228-264.
- Choi, J., Choi, S., Hogan, C., & Lee, J. (2013). The effect of human resource investment in internal control on the disclosure of internal weaknesses. Auditing: A Journal of Practice and Theory, 32(4), 169-199.
- Collins, D., & Kothari, S. P. (1989). An analysis of the intertemporal and cross-sectional determinants of the earnings response coefficient. Journal of Accounting and Economics, 11(2-3), 143-181.
- COSO (The Committee of Sponsoring Organizations). (2013). Internal Control-Integrated Framework.
- Dechow, P., & Dichev, I. (2002). The quality of accruals and earnings: The role of accrual estimation errors. The Accounting Review, 77(s-1), 35-59.
- Deloitte Development LLC. (2013). COSO 2013 Framework on Internal Control Prepare for the changes.
- Dhaliwal, D. S., Lee, K. J., & Fargher, N. L. (1991). The association between unexpected earnings and abnormal security returns in the presence of financial leverage. Contemporary Accounting Research, 8(1), 20-41.
- Doyle, J., Ge, W., & McVay, S. (2007). Accruals quality and internal control over financial reporting. The Accounting Review, 82(5), 1141-1170.
- Fama, E., & French, K. (1995). Size and book-to-market factors in earnings and returns. Journal of Finance, 50(1), 131-155.
- Fama, E., & French, K. (2006). Profitability, investment and average returns. Journal of Financial Economics, 82(3), 491-518.
- Fargher, N., & Gramling, A. (2005). Toward improved internal controls: early remediation actions disclosed. The CPA Journal, 75(6), 26-29.
- Francis, J., & Ke, B. (2006). Disclosure of fees paid to auditors and the market valuation of earnings surprises. Review of Accounting Studies, 11(4), 495-523.
- Francis, J., & Schipper, K. (1999). Have financial statement lost their relevance? Journal of Accounting Research, 37(2), 319-352.
- Francis, J., LaFond, R., Olsson, P., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review, 79(4), 967-1010.
- Frankel, R., Johnson, M., & Nelson, K. (2002). The relation between auditors’ fee for nonaudit services and earnings management. The Accounting Review, 77, 71-105.
- Ge, W., & McVay, S. (2005). The disclosure if material weaknesses in internal control after the Sarbanes-Oxley Act. Accounting Horizons, 19(3), 137-158.
- Hammersley, J. S., Myers, L., & Shakespeare C. (2008). Market reactions to the disclosure of internal control weaknesses and to the characteristics of those weaknesses under section 302 of the Sarbanes Oxley Act of 2002. Review of Accounting Studies, 13(1), 141-165.
- Lee, J. (2015). Internal control weakness and investment efficiency: Evidence from Korea. Korean Accounting Review, 40(2), 109-149.
- Lemmon, M. L., & Lins, K. V. (2003). Ownership structure, corporate governance, and firm value: Evidence from the East Asian Financial Crisis. The Journal of Finance, 58(4), 1445-1468.
- Nissim, D., & Penman, S. (2001). Ratio Analysis and Equity Valuation: From Research to Practice. Review of Accounting Studies, 6(1), 109-154.
- Ohlson, J. (1995). Earnings, book values and dividends in security valuation. Contemporary Accounting Research, 11(2), 661-687.
- Ou, J., & Penman, S. (1989). Financial statement analysis and the prediction of stock returns. Journal of Accounting and Economics, 11(4), 295-329.
- PCAOB (Public Company Accounting Oversight Board). (2008). Audit considerations in the current economic environment (Staff Audit Practice Alert No. 3). Washington. D. C.
- Rattiner, J. H. (2008). Financial Planning Answer Book. Chicago: CCH.
- Reilly, F. K., & Brown, K. C. (2011). Investment Analysis and Portfolio Management. Mason, OH: Cengage Learning.
- Shin, I., Lee, H., Lee, H., & Son, M. (2016). How does human resource investment in internal control affect audit reporting lag? Asia-Pacific Journal of Accounting and Economics, 24(1-2), 195-215.