Internal control material weakness, analysts’ accuracy and bias, and brokerage reputation

Internal control material weakness, analysts’ accuracy and bias, and brokerage reputation The main purpose of this paper is to examine the impact of internal control material weaknesses (ICMW hereafter) on sell side analysts. We find that ICMW reporting firms have less accurate analyst forecasts relative to non-reporting firms when the reported ICMWs belong to the Pervasive type. ICMW reporting firms have more optimistically biased analyst forecasts compared than non-reporting firms. The optimistic bias exists only in the forecasts issued by the analysts affiliated with less-highly-reputable brokerage houses. The differences in accuracy and bias between ICMW and non-ICMW firms disappear when ICMW disclosing firms stop disclosing ICMWs. Collectively, our results suggest that the weaknesses in internal control increases forecasting errors and upward bias for financial analysts. However, a good brokerage reputation can curb the optimistic bias. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Internal control material weakness, analysts’ accuracy and bias, and brokerage reputation

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Publisher
Springer US
Copyright
Copyright © 2011 by Springer Science+Business Media, LLC
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-011-0243-2
Publisher site
See Article on Publisher Site

Abstract

The main purpose of this paper is to examine the impact of internal control material weaknesses (ICMW hereafter) on sell side analysts. We find that ICMW reporting firms have less accurate analyst forecasts relative to non-reporting firms when the reported ICMWs belong to the Pervasive type. ICMW reporting firms have more optimistically biased analyst forecasts compared than non-reporting firms. The optimistic bias exists only in the forecasts issued by the analysts affiliated with less-highly-reputable brokerage houses. The differences in accuracy and bias between ICMW and non-ICMW firms disappear when ICMW disclosing firms stop disclosing ICMWs. Collectively, our results suggest that the weaknesses in internal control increases forecasting errors and upward bias for financial analysts. However, a good brokerage reputation can curb the optimistic bias.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: May 24, 2011

References

  • Industry costs of equity
    Fama, E; French, K
  • Analyst earnings forecasts for publicly traded insurance companies
    Fan, D; Yeh, J
  • Internal control and management guidance
    Feng, M; Li, C; McVay, S
  • On the disclosure of material weaknesses in internal control after the Sarbanes-Oxley act
    Ge, W; McVay, S
  • Rationality and analysts’ forecast bias
    Lim, T

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