Internal Control Disclosures, Monitoring, and the Cost of Debt

Dhaliwal, Dan S.; Hogan, Chris E.; Trezevant, Robert; Wilkins, Michael S.

doi:10.2308/accr-10043

Cited by 267 publications

(180 citation statements)

References 33 publications

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“…We also find that our results are robust when we use individual CDS contracts directly, similar to Callen et al (2009), instead of averaging CDS spreads across all contracts for the same name. In addition, when we restrict our sample of companies to those covered by rating agencies, we find results similar to those reported in Tables 3-5, which suggests that the effect of MWs on CDS spreads is beyond the rating agency monitoring channel documented by Dhaliwal et al (2011).…”

Section: Robustness Checkssupporting

confidence: 76%

“…We further show that the severity of internal control weaknesses (company-level versus account-specific) influences CDS spreads and that remediating internal control MWs reduces CDS spreads. These findings improve our understanding of the findings of Dhaliwal et al (2011) and Costello and Wittenberg-Moerman (2011).…”

Section: Introductionsupporting

confidence: 60%

“…Dhaliwal et al (2011) find that corporate bond spreads are marginally higher for firms disclosing internal control MWs, but this relationship is non-existent for firms monitored by banks.…”

mentioning

confidence: 78%

“…Several studies use debt market data-such as bank loans and public bonds-to investigate the relationship between internal control quality and credit spreads, but these studies have also produced inconsistent results. Although Kim et al (2011) demonstrate that bank loan rates are higher for companies with internal control MWs than for firms without such MWs, Dhaliwal et al (2011) find that there is no association between reporting internal control MWs and increased bond spreads in their study of companies monitored by banks or rating agencies (essentially large firms). Moreover, Kim et al (2011) show that the remediation of internal control MWs is related to decreased credit spreads, but Costello and Wittenberg-Moerman (2011) find no evidence for such a remediation effect.…”

Section: Introductionmentioning

confidence: 86%

“…Moreover, Kim et al (2011) show that the remediation of internal control MWs is related to decreased credit spreads, but Costello and Wittenberg-Moerman (2011) find no evidence for such a remediation effect. Furthermore, Kim et al (2011) find that credit spreads are higher for companies with company-level internal control MWs than for companies with account-specific internal control MWs, but Dhaliwal et al (2011) find no such difference.…”

Section: Introductionmentioning

confidence: 93%

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Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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i Internal Control Quality and Credit Default Swap SpreadsSYNOPSIS: This paper presents the first study on the effects of internal control quality on derivatives pricing. Specifically, we utilize data from the credit default swap (CDS) transactions of well-monitored companies to examine the relationship between the quality of internal control and the cost of debt. The CDS data we employ are advantageous for our analysis because CDS contracts are comparatively more homogeneous, standardized, and liquid than bank loans and public bonds. We find that CDS spreads increase around the disclosure of internal control material weaknesses (MWs) and that, all else equal, companies experiencing MWs with respect to internal control have higher CDS spreads than companies with effective internal control.Moreover, companies with company-level MWs have higher CDS spreads than those with less severe, account-specific MWs. In addition, remediating internal control MWs is associated with a decrease in CDS spreads. Our study offers a new perspective on the relationship between the quality of internal control and the cost of debt. These conflicting results may be due to heterogeneous characteristics and measurement issues in using bank loans and public bonds to measure credit spreads. Covenants, embedded optionalities (such as callability and convertibility), and other complicating factors associated with bank loans and public bonds may distort the relationship between credit risk and internal control quality. Furthermore, because information on bank loans is only available when companies receive new loans, researchers are relegated to three-or four-year windows in their observations of changes in loan spreads (Dahilwal et al. 2011). By contrast, CDS contracts are relatively homogeneous and standardized, and CDS spreads reflect credit risk better than loan or 3 bond spreads (Shivakumar et al. 2011;Callen et al. 2009) because the CDS market is not as plagued with the liquidity issues that affect the public bond and bank loan markets. Therefore, CDS spreads are a superior means of examining the impact of internal control quality on credit pricing.We expect CDS spreads to be positively related to internal control MWs for two reasons.First, a firm that is experiencing MWs in internal control suggests that its financial reporting may be unreliable, which thereby increases the perceived information risk from the perspective of a credit investor. Such information risk related to unreliable information sources leads an investor to charge a higher credit risk premium (e.g., Duffie and Lando 2001;Lambert et al. 2007).Second, internal control MWs make it easier for managers to misappropriate a company's assets, which increases the default risk. For example, Skaife et al. (2013) report that the profitability of insider trading is significantly greater in firms with internal control MWs, which suggests the risk of expropriation of outside shareholders when there are weak internal controls.In an examination of the period from November 15, 2004, ...

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Section: Robustness Checkssupporting

confidence: 76%

Section: Introductionsupporting

confidence: 60%

“…Dhaliwal et al (2011) find that corporate bond spreads are marginally higher for firms disclosing internal control MWs, but this relationship is non-existent for firms monitored by banks.…”

mentioning

confidence: 78%

Section: Introductionmentioning

confidence: 86%

Section: Introductionmentioning

confidence: 93%

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Internal Control Quality and Credit Default Swap Spreads

Tang

Tian

Yan

2015

Accounting Horizons

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Material Weaknesses in Internal Control in Relation to Derivatives and Hedge Accounting

Lee¹,

Park²,

Song³

et al. 2018

J Corp Accounting Finance

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We examined 173 internal control reports containing material weaknesses (MW) in internal control over financial reporting related to derivatives and hedge accounting issues (FASB codification ASC 815). We found that a majority of the companies (122) did not properly implement the ASC 815 accounting rules, followed by inadequate monitoring and review (72), insufficient resources (61), incomplete documentation for hedge effectiveness (49), and inaccurate valuation (32). We also found that companies with MW mostly fixed their problems by process and procedure improvement (205), training expansion (60), engaging external specialists (53), and increasing staffing (52). Our review and discussion of the MW in internal control related to ASC 815 should benefit external auditors, management, and regulators. © 2018 Wiley Periodicals, Inc.

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Private lenders and borrowers’ internal control weaknesses

Hasan

2021

J Corp Accounting Finance

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This study examines whether the presence of private lenders is associated with the effectiveness of borrowers’ internal controls. I provide evidence that the presence of private lenders is an important determinant of internal control weaknesses in borrower firms. To monitor loan contracts, lenders use borrowers’ financial information, reliability of which to a great extent depends on the effectiveness of borrowers’ internal controls. I argue that lenders are likely to influence borrowers to maintain effective internal controls so that they can reliably use borrowers’ financial reporting information. Using a battery of tests, I find that the presence of private lenders has a significant negative association with the probability of borrowers’ disclosing a material weakness in internal controls.

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Internal Control Disclosures, Monitoring, and the Cost of Debt

Cited by 267 publications

References 33 publications

Internal Control Quality and Credit Default Swap Spreads

Internal Control Quality and Credit Default Swap Spreads

Material Weaknesses in Internal Control in Relation to Derivatives and Hedge Accounting

Private lenders and borrowers’ internal control weaknesses

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