Unintended consequences of internal controls over financial reporting

This study investigates the impact of internal controls over financial reporting requirements (ICFR) enacted as part of the Sarbanes-Oxley Act of 2002 on the judgment and decision making of corporate tax executives. Prior research indicates that companies with disclosed material weaknesses in internal controls face significant capital-markets based consequences (Ashbaugh-Skaife et al. 2009; Hammersley 2008; Cheng et al. 2006). However, prior research has not examined whether these consequences impact the decision making of corporate executives. The current study examines the decisions of corporate tax executives to amend or not amend a prior year tax return when a discovered error will be classified as either a significant deficiency or a material weakness. Although the overall likelihood to amend the tax return is high, I find that tax executives are less likely to amend a prior year tax return when the cause of the discovered error will be classified as a material weakness than when the cause will be classified as a significant deficiency. This result indicates that the required ICFR disclosure rules impact company executives' decisions. In addition, if executives are willing to hide or not disclose an internal control deficiency, the overall reliability of the reporting on ICFR may be limited.