Are Material Weaknesses in Internal Controls Associated with Poor M&A Decisions? Evidence from Goodwill Impairment
Posted: 21 Feb 2017 Last revised: 5 Jan 2022
Date Written: February 15, 2017
Abstract
This paper examines the effect of the quality of a firm’s internal control over financial reporting (ICFR) on the quality of corporate M&A decisions. We use material weaknesses in internal control (ICMWs) from SOX 404 audits as a proxy for the quality of a firm’s ICFR, and use future goodwill impairment to proxy for the quality of managers’ M&A decisions. We find that goodwill recognized from acquisitions in years concurrent with ICMW has a greater rate of impairment in subsequent years than goodwill recognized from acquisitions in years without ICMW, thereby establishing a link between ICMW and goodwill impairment. We further show that disclosure and remediation of ICMWs appear to improve valuations of subsequent acquisitions. Our study contributes to the literature on internal controls by documenting unanticipated benefits of SOX 404 audits on managerial performance, and to the goodwill literature by identifying ICMW as a determinant of goodwill impairment.
Keywords: internal control, material weaknesses, SOX 404, goodwill impairment, mergers and acquisitions
JEL Classification: M41, M42, G38
Suggested Citation: Suggested Citation