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Do customers respond to the disclosure of internal control weakness?

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  • Su, Lixin (Nancy)
  • Zhao, Xuezhou (Rachel)
  • Zhou, Gaoguang (Stephen)

Abstract

In this study, we investigate the effects of firms' internal control weakness (ICW) disclosures on their customers. We hypothesize that ICW disclosure adversely affects customers' perceptions of firms' ability and incentive to honor implicit commitments to customers, and as such, customers are less willing to buy from such firms. We thus expect a decline in firms' sales growth after ICW disclosure. We find a significant decline in sales growth subsequent to Sarbanes–Oxley (SOX) Section 404 ICW disclosure after controlling for firms' past sales growth and other factors affecting sales performance and internal control. This result is robust to the consideration of selection bias in ICW disclosure. We also find that the decline is more pronounced for firms with company-level ICW disclosure, with industrial customers, in the durable goods industries, with high research and development (R&D) intensity, or without subsequent remediation of ICW. Taken together, these results are consistent with the argument that ICW concerns customers more when the implicit contracts between the firms and their customers are more intensive.

Suggested Citation

  • Su, Lixin (Nancy) & Zhao, Xuezhou (Rachel) & Zhou, Gaoguang (Stephen), 2014. "Do customers respond to the disclosure of internal control weakness?," Journal of Business Research, Elsevier, vol. 67(7), pages 1508-1518.
    • Handle: RePEc:eee:jbrese:v:67:y:2014:i:7:p:1508-1518
    DOI: 10.1016/j.jbusres.2013.06.009
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    3. Cano-Rodríguez, Manuel & Márquez-Illescas, Gilberto & Núñez-Níckel, Manuel, 2017. "Experts or rivals: Mimicry and voluntary disclosure," Journal of Business Research, Elsevier, vol. 73(C), pages 46-54.
    4. Oliver Henk, 2020. "Internal control through the lens of institutional work: a systematic literature review," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 31(3), pages 239-273, September.
    5. Jamaliah Said & Md. Mahmudul Alam & Nurazwani Binti Mat Radzi & Mohamad Hafiz Rosli, 2020. "Impacts of accountability, integrity, and internal control on organisational value creation: evidence from Malaysian government linked companies," International Journal of Business Governance and Ethics, Inderscience Enterprises Ltd, vol. 14(2), pages 206-223.
    6. Young Joo Park & David S.T. Matkin & Justin Marlowe, 2017. "Internal Control Deficiencies and Municipal Borrowing Costs," Public Budgeting & Finance, Wiley Blackwell, vol. 37(1), pages 88-111, March.
    7. Puji Rahayu Setyaningsih & Nengzih Nengzih, 2020. "Internal Control, Organizational Culture, and Quality of Information Accounting to Prevent Fraud: Case Study From Indonesia's Agriculture Industry," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 11(4), pages 316-328, July.
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    More about this item

    Keywords

    Internal control weakness; SOX Section 404; Implicit contract; Sales growth;
    All these keywords.

    JEL classification:

    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing
    • M48 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Government Policy and Regulation

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