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Internal Control Weaknesses and Financial Reporting Fraud

Year: 2014

Type: article

Abstract: SUMMARY This study examines whether and how weak internal controls increase the risk of financial reporting fraud by top managers. There is a longstanding debate on whether control strength significantly affects fraud risk, yet little evidence on this issue. Further, there is no evidence on the mechanism linking control strength to fraud risk. We find a strong association between material weaknesses and future fraud revelation. We theorize that this link could be attributable to weak controls (1) giving managers greater opportunity to commit fraud, or (2) signaling a management characteristic that does not emphasize reporting quality and integrity. We find support for the opportunity explanation, but not through specific accounts linked to control weaknesses. Instead, consistent with the PCAOB's assertion, weaknesses in entity-wide controls, not process-level controls, are associated with a higher risk of reporting fraud. JEL Classifications: M41.

Source: Auditing A Journal of Practice & Theory

DOI: 10.2139/ssrn.2449287

Authors: Dain C. Donelson, Matthew Ege, John M. McInnis

Institutions: University of Wisconsin–Madison, The University of Texas at Austin, Texas A&M University

Language: English

Topic: Auditing, Earnings Management, Governance

Subfield: Accounting

Field: Business, Management and Accounting

Domain: Social Sciences

SDG: Peace, justice, and strong institutions

Open Access status: green

OpenAlex ID: W3122394326

FWCI: 14.18

Cites: 43

Cited by: 238

Related to: 10