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Internal control weakness, investment and firm valuation

Author

Listed:
  • Jacoby, Gady
  • Li, Yingqi
  • Li, Tianze
  • Zheng, Steven Xiaofan

Abstract

We propose reduced investment as a potential explanation for why firms with internal control weakness (ICW) exhibit lower valuation relative to non-ICW firms. We show that ICW firms significantly reduce investment around ICW disclosure and also have poor stock performance. Additional evidence shows that many of the investment reductions have been announced during the year before ICW disclosure. A possible explanation for investment reductions is the higher costs of financial friction associated with ICW. Consistent with this explanation, we show that ICW firms with credit ratings do not reduce their investment as much and have much better stock performance than ICW firms without credit ratings.

Suggested Citation

  • Jacoby, Gady & Li, Yingqi & Li, Tianze & Zheng, Steven Xiaofan, 2018. "Internal control weakness, investment and firm valuation," Finance Research Letters, Elsevier, vol. 25(C), pages 165-171.
  • Handle: RePEc:eee:finlet:v:25:y:2018:i:c:p:165-171
    DOI: 10.1016/j.frl.2017.10.018
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    References listed on IDEAS

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    1. Li, Yingqi & Yu, Junli & Zhang, Zhou & Zheng, Steven Xiaofan, 2016. "The effect of internal control weakness on firm valuation: Evidence from SOX Section 404 disclosures," Finance Research Letters, Elsevier, vol. 17(C), pages 17-24.
    2. Biddle, Gary C. & Hilary, Gilles & Verdi, Rodrigo S., 2009. "How does financial reporting quality relate to investment efficiency?," Journal of Accounting and Economics, Elsevier, vol. 48(2-3), pages 112-131, December.
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    5. Aloke (Al) Ghosh & Yong Gyu Lee, 2013. "Financial Reporting Quality, Structural Problems and the Informativeness of Mandated Disclosures on Internal Controls," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 40(3-4), pages 318-349, April.
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    11. Cheng, Mei & Dhaliwal, Dan & Zhang, Yuan, 2013. "Does investment efficiency improve after the disclosure of material weaknesses in internal control over financial reporting?," Journal of Accounting and Economics, Elsevier, vol. 56(1), pages 1-18.
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    More about this item

    Keywords

    Sarbanes–Oxley act; Internal control weakness; Stock performance; q theory of investments; Benchmark adjusted returns; Credit ratings;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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