Do customers respond to the disclosure of internal control weakness?

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

Journal of Business Research, 2014, vol. 67, issue 7, 1508-1518

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.

Keywords: Internal control weakness; SOX Section 404; Implicit contract; Sales growth (search for similar items in EconPapers)
JEL-codes: L14 M41 M42 M48 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbrese:v:67:y:2014:i:7:p:1508-1518

DOI: 10.1016/j.jbusres.2013.06.009

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