Do customers respond to the disclosure of internal control weakness?

Lixin (Nancy) SU, Xuezhou (Rachel) ZHAO, Gaoguang (Stephen) ZHOU

Research output: Journal PublicationsJournal Article (refereed)

15 Citations (Scopus)

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 (RandD) 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.
Original languageEnglish
Pages (from-to)1508-1518
Number of pages11
JournalJournal of Business Research
Volume67
Issue number7
Early online date23 Jul 2013
DOIs
Publication statusPublished - Jul 2014
Externally publishedYes

Bibliographical note

Financial support provided by the Hong Kong Polytechnic University Departmental Research grant (#4-ZZ8S).

Keywords

  • Implicit contract
  • Internal control weakness
  • SOX section 404
  • Sales growth

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