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Internal control quality and relationship‐specific investments by suppliers and customers

Shu‐Miao Lai

Journal of Business Finance & Accounting, 2019, vol. 46, issue 9-10, 1097-1122

Abstract: This paper investigates the association between the quality of internal control over financial reporting (ICOFR) and relationship‐specific investments by suppliers/customers. I find a significant negative association between the disclosure of a material weakness (MW) in ICOFR and changes in the relationship‐specific investments of suppliers/customers. Relationship‐specific investments of suppliers/customers have a stronger negative association with inventory‐related MW. The negative association between MW disclosures and the relationship‐specific investments of suppliers/customers is stronger when economic dependence between the firms and the suppliers/customers is more important and when the suppliers/customers have greater bargaining power. Also, suppliers/customers significantly increase their relationship‐specific investments following the remediation of ineffective ICOFR. Overall, my findings show that a firm's quality of ICOFR affects the relationship‐specific investment decisions of suppliers/customers.

Date: 2019
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Journal of Business Finance & Accounting is currently edited by P. F. Pope, A. W. Stark and M. Walker

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