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The relationship between Material Weaknesses in Internal Controls over Financial Reporting and Executive Turnover: Evidence from Japan

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  • Uemura, Hiroshi
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    Abstract

    This study examines the relationship between material weaknesses in internal controls over financial reporting and executive turnover. The result of the analysis of 3,391 listed company in Japan show that corporations that disclose material weaknesses change chief executives more frequently. This suggests that corporations’ boards believe that the quality of internal controls critically impacts the credibility of financial statements. In a sample corporations with a material weakness, this study further examines the relationship between remediation of previously- disclosed material weaknesses and executive turnover. The results indicate that chief executive turnover does not have a statistically significant correlation with material weakness disclosures for two consecutive years. In contrast, both a board members’ expertise and a proportion of outside shareholders have significant negative correlations with material weakness disclosures for two consecutive years. These results suggest that internal and external monitoring functions have a greater impact on the remediation of material weaknesses than chief executive turnover. In addition, these sample companies are used to examine the relationship between chief executive turnover and audit fees. This result reveals that chief executive turnover after the disclosing material weaknesses has a significantly negative correlation with the difference of the audit fees between the previous and the following terms. This finding suggests the possibility that auditors perceive chief executive turnover after disclosure of material weakness as the board’s response to a legitimacy crisis.

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    File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/22921/1/070hibsWP_141.pdf
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    Bibliographic Info

    Paper provided by Center for Japanese Business Studies (HJBS), Graduate School of Commerce and Management Hitotsubashi University in its series Working Paper Series with number 141.

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    Length: 29 p.
    Date of creation: Apr 2012
    Date of revision:
    Handle: RePEc:hit:hjbswp:141

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    Web page: http://www.cm.hit-u.ac.jp/hjbs/
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    Keywords: internal controls audit; material weaknesses; executive turnover;

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    1. Kaplan, Steven N. & Minton, Bernadette A., 1994. "Appointments of outsiders to Japanese boards: Determinants and implications for managers," Journal of Financial Economics, Elsevier, vol. 36(2), pages 225-258, October.
    2. Weisbach, Michael S., 1988. "Outside directors and CEO turnover," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 431-460, January.
    3. John, Kose & Lang, Larry H P & Netter, Jeffry, 1992. " The Voluntary Restructuring of Large Firms in Response to Performance Decline," Journal of Finance, American Finance Association, vol. 47(3), pages 891-917, July.
    4. Morck, Randall & Shleifer, Andrei & Vishny, Robert W., 1988. "Management ownership and market valuation : An empirical analysis," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 293-315, January.
    5. Agrawal, Anup & Chadha, Sahiba, 2005. "Corporate Governance and Accounting Scandals," Journal of Law and Economics, University of Chicago Press, vol. 48(2), pages 371-406, October.
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