Real earnings management before and after reporting SOX 404 material weaknesses

Tuukka Järvinen, Emma Riikka Myllymäki

Research output: Contribution to journalArticleScientificpeer-review

15 Citations (Scopus)

Abstract

The purpose of this study is to investigate whether SOX Section 404 material weaknesses manifest in real earnings management behavior. The empirical findings indicate that, compared to companies with effective internal controls, companies with existing material weaknesses in their internal controls engage in more manipulation of real activities (particularly inventory overproduction). This implies that the weak commitment by management to provide effective internal control system and high-quality financial information relates to a tendency to use real earnings management methods. Moreover, we find evidence suggesting that companies employ real earnings management (overproduction and reduction of discretionary expenses) after disclosing previous year’s material weaknesses. We conjecture that the public disclosure of material weaknesses induces management to strive to mitigate the expected negative reactions of stakeholders to the disclosure by engaging in real earnings management, which is not easily detected or constrained by outsiders. Overall, this study suggests that material weaknesses in internal controls signal an environment where management is more inclined to employ real earnings management.

Original languageEnglish
Pages (from-to)119-141
JournalACCOUNTING HORIZONS
Volume30
Issue number1
DOIs
Publication statusPublished - 1 Mar 2016
MoE publication typeA1 Journal article-refereed

Keywords

  • Internal control
  • Material weakness
  • Real earnings management

Fingerprint Dive into the research topics of 'Real earnings management before and after reporting SOX 404 material weaknesses'. Together they form a unique fingerprint.

Cite this