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Tax Consulting and Reported Weaknesses in Internal Control

Randal Elder Associate Professor of Accounting Lubin School of Accounting Whitman School of Management Syracuse University Syracuse, NY 13244 Tel: (315) 443-3359 Email: [email protected]

David Harris Associate Professor of Accounting Lubin School of Accounting Whitman School of Management Syracuse University Syracuse, NY 13244 Tel: (315) 443-3362 Email: [email protected]

Jian Zhou Assistant Professor of Accounting School of Management SUNY at Binghamton PO Box 6000 Binghamton, NY 13902-6000 USA Email: [email protected]

Tax Consulting and Reported Weaknesses in Internal Control

Abstract

Audit firms are restricted from provided most nonaudit services to their public company audit clients. A notable exception is tax consulting services. We examine whether tax consulting services are associated with the likelihood of tax-related and other material weaknesses in internal control. The extent of tax consulting measured by the ratio of tax fees to total fees is associated with a significantly lower likelihood of a taxrelated internal control weaknesses, but an indicator variable for the presence of tax consulting is not. The tax fee ratio is also associated with a reduced likelihood of other types of internal control weaknesses. These results are consistent with auditor-provided tax services reducing independence, rather than knowledge spillovers arising from the provision of tax services.

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Tax Consulting and Reported Weaknesses in Internal Control

I. INTRODUCTION

The relation between nonaudit services and auditor performance came under significant scrutiny in the period leading up to the collapse of Enron and the passage of the Sarbanes-Oxley Act of 2002 (SOX). In 2000 the SEC initially proposed prohibiting CPA firms from providing any nonaudit services to audit clients, but ultimately restricted only certain nonaudit services (SEC 2000). SOX expanded the list of prohibited services, but did not completely restrict the ability of audit firms to provide nonaudit services to their public company audit clients. Tax consulting was one of the allowed nonaudit services. The SEC adopted rules in 2003 that specifically prohibited the nonaudit services specified in SOX. However, possible restrictions on tax services were heavily debated. The SEC did not restrict tax services at that time, but did caution audit committees to scrutinize the tax services that auditors might provide before approving them. Tax services continued to remain under scrutiny. For example, Ernst & Young provided tax consulting to executives at Sprint that allegedly created a conflict of interest in the performance of the audit. KPMG also came under scrutiny for the development of tax shelters that the IRS considered abusive. In 2005 the PCAOB restricted auditors from providing to a public company audit client, (1) certain aggressive tax shelters, (2) any other service for a contingent fee, and (3) any tax service to individuals who serve in a financial reporting oversight role. However, all other tax compliance and advisory services continue to be allowed. The major accounting firms argue that there is no evidence that provision of these services impairs independence, and there a benefits to the joint provision of these services. 2

There is limited evidence from previous studies that nonaudit services affect auditor independence. For example, DeFond et al. (2002) do not find a relationship between nonaudit services and going concern opinions. Frankel et al. (2002) find that nonaudit services are associated with increased discretionary accruals and the achievement of certain earnings benchmarks, consistent with auditors allowing increased management discretion when the audit firm also provides non-audit services. Ferguson et al. (2004) find similar results for UK firms. However, studies by Ashbaugh et al. (2003), Chung and Kallapur (2003), Reynolds et al. (2002), and Francis and Ke (2002) find no relationship between non-audit fees and auditor independence. The mixed results in previous studies suggest the need for additional research. These previous studies test for potential negative independence effects associated with the provision of nonaudit services. However, they are unable to test for the existence of any positive knowledge spillovers from the provision of nonaudit services. Auditor reports on internal control required by Section 404 allow us to test for both the existence of knowledge spillovers and effects on auditor independence. The provision of tax consulting services should provide positive benefits such that tax-related material weaknesses in internal control are less likely. However, tax services should not impact the likelihood of other internal control weaknesses (ICW). We examine companies issuing reports on internal control for the period 2004-06. We find that the extent of tax consulting measured by the ratio of tax fees to total fees is associated with a reduced likelihood of all types of internal control weaknesses. A dichotomous indicator of the mere fact that tax consulting is provided is not associated with a reduced likelihood of tax ICWs. These results provide minimal evidence of knowledge

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spillovers, and suggest auditor provision of tax consulting services may adversely impact independence. The remainder of the paper is organized as follows. The next section describes the relation between nonaudit services and auditor reporting, and includes the research hypotheses. Section III describes the research design. Sample selection and tests of the relation between tax consulting and internal control weaknesses are discussed in Section IV. Section V is the summary and conclusion.

II. RELATED RESEARCH Nonaudit Services and Auditor Reporting Nonaudit services have long been a contentious issue for the accounting profession. Proponents argue that they improve overall service quality or efficiency, while opponents argue that nonaudit services weaken auditor independence by expanding the economic ties between the auditor and the client. For example, the Metcalf Committee (1977) suggested that supplying both audit and nonaudit services can create a conflict of interest, while the Cohen Commission (1978) did not find any significant relationship between nonaudit services and substandard audits. Nonaudit services increase the total amount of revenues the audit firm receives from the client. As a result, the economic bond between the auditor and the client is increased, and independence decreased. Simunic (1984) notes, “In general, any situation which increases the probability that an auditor will not truthfully report the results of his audit investigation can be viewed as a threat to independence” (p. 679) and may impair

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independence. The alternative viewpoint is that nonaudit services provide knowledge spillovers that allow auditor firms to provide audit or nonaudit services more effectively. Early literature on nonaudit services focused on the relation between nonaudit services and audit fees. Simunic (1984) provides a comprehensive set of plausible relationships between audit and nonaudit fees. The relationship is complex, as knowledge spillovers can occur both to and from nonaudit services, and spillovers can affect fixed set up costs or marginal costs of the audit or nonaudit services. Previous studies generally find that audit fees are higher for companies that purchase nonaudit services from their auditor (e.g., Simunic 1984; Simon 1985; Palmrose 1986; Davis et al. 1993). The positive relationship between audit and nonaudit services even exists when companies purchase nonaudit services from a firm different than the firm providing the audit services (Palmrose 1986). In general, fee studies do not support the existence of knowledge spillovers. Whisenant et al. (2003) document that audit and nonaudit fees are jointly determined and there is no association between audit and nonaudit fees using a simultaneous specification of the fee system. Their findings are not consistent with the existence of economies of scope from the joint performance of audit and non-audit services. Because nonaudit services are not associated with lower audit fees, the usual conclusion is that nonaudit services do not create knowledge spillovers to auditing. 1 However, because of their focus on audit fees, these previous studies mainly provide evidence on whether nonaudit services allow auditors to provide audits more efficiently, that is, at lower cost. However, nonaudit services may allow the auditor to provide audit services more effectively, resulting in higher quality. This might be the case if the nonaudit

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services provide knowledge that is useful to the auditor in conducting the audit. Section 404 reporting on internal control provides an opportunity to test whether a specific type of nonaudit service, tax consulting, provides positive benefits such that the likelihood of a tax ICW is reduced. Frankel et al. (2002) examine the relation between nonaudit services and measures of audit quality. They find that companies’ ability to meet earnings forecasts is positively related to the extent of nonaudit services, although not the ability to exceed prior year earnings benchmarks. They also find that discretionary accruals are positively related to the extent of nonaudit services. They interpret this evidence as supporting the argument that nonaudit services result in auditors allowing greater accounting discretion. Several subsequent studies have questioned the results in Frankel et al. (2002). Several studies question the positive relation between nonaudit fees and discretionary accruals. Chung and Kallapur (2003) find no relation between nonaudit services and discretionary accruals. Reynolds et al. (2002) find the opposite result; their study finds a negative relationship between nonaudit fees and discretionary accruals. Finally, Ashbaugh et al. (2003) replicate the Frankel et al. (2002) results, but find that the relation between nonaudit fees and discretionary accruals is driven by firms with income-decreasing discretionary accruals. Since such accruals do not result in an overstatement of earnings, they argue that this does not support impairment of independence by nonaudit services. Raghunandan et al. (2003) find that there are no significant differences in unexpected audit fees, fee ratios and total fees between companies restating financial statements and control samples. They interpret their findings as indicating that nonaudit fees or total fees do not inappropriately influence the audit and lead to restatements.

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Francis and Ke (2002) replicate the Frankel et al. result of a positive association between nonaudit fees and positive earnings surprises using quarterly earnings announcements for the period 1997-2000. However, similar to the results in Ashbaugh et al. (2003), they find that the significant relation between non-audit fees and earnings surprises is driven by observations with large negative earnings surprises. There is no significant association between nonaudit fees and earnings surprises when the sample is restricted to observations with small positive and negative earnings surprises. DeFond et al. (2002) use auditor going concern opinions, rather than discretionary accruals, to address the effect of nonaudit fees on auditor independence. They do not find a relation between the extent of nonaudit services and auditors’ propensity to issue going concern audit opinions, a proxy measure for impaired auditor independence. They suggest that market-based incentives, such as loss of reputation and litigation costs, dominate the expected benefits from compromising auditor independence.

Tax Consulting and Reporting Quality Kinney et al. (2004) examine whether there is a relation between earnings restatements and nonaudit services. They do not find an association between restatements and financial information system design and implementation, but do find some positive association between unspecified nonaudit services and restatements. They also find a significant negative association between tax service fees and restatements. They suggest that the financial reporting quality benefits of auditor-provided tax services outweigh any fee economic dependence, or high reporting quality firms choose their audit firm to provide tax advice. They argue that banning or restricting tax services may either reduce reporting

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quality or increase the cost of professional services without corresponding benefits from improved independence. Gleason and Mills (2007) examine whether auditor-provided tax services improves tax estimation expense. They find that companies using auditor provided tax services record reserves for tax loss contingencies sooner. They also do not find evidence that companies that use the same audit firm for tax and audit services have smoother earnings or use tax expense to beat analyst forecasts. They argue their results are consistent with provision of tax services providing knowledge spillovers, rather than opportunism. These studies indicate potential positive benefits of auditor-provided tax services. We examine whether provision of tax consulting is associated with a reduced likelihood of tax-related ICWs and state the following hypothesis in null form:

H1:

There is no association between auditor tax consulting and the likelihood of tax-related ICWs.

A reduced incidence of tax-related ICWs associated with tax consulting could reflect positive spillovers in the form of improvements in the client’s tax reporting systems. However, a reduced incidence of tax ICWs could also reflect adverse effects on auditor independence. On the other hand, tax consulting should not provide spillovers to other types of consulting. Accordingly, we state the following hypothesis in null form: H2:

There is no association between auditor tax consulting and the likelihood of non-tax-related ICWs.

Previous studies have examined overall auditor reporting. Since tax consulting should not have any spillover effects on other types of ICWs, comparison of the effects of

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tax consulting on tax ICWs and other ICWs should allow us to disentangle these two effects.

III.

RESEARCH DESIGN

Internal Control Weaknesses We collect data on internal control weaknesses from the Audit Analytics database for the period 2004-2006. In our empirical tests we control for the likelihood of receiving a material internal control weakness based on the models in Doyle et al. (2007a) (hereafter DGM) and Ashbaugh-Skaife et al. (2007) (hereafter ACK). As discussed in Leone (2007), these studies differ in that ACK focus on voluntary disclosure of significant deficiencies and material weakness prior to implementation of Section 404, while DGM focus on mandatory disclosure of material weaknesses under Section 404. However, the models are largely consistent in approach and their findings. The likelihood of receiving a material internal control weakness is based on the following model: ICWit = β0 + β1ABSDACCRit + β2SIZEit + β3LOGAGEit + β4AGG_LOSSit + β5ZSCOREit + β6LOGSEGit + β7GROWTHit + β8FOREIGNit + β9RESTRit + εit Where: ICW: ABSDACCR: SIZE: LOGAGE: AGG_LOSS: ZSCORE: LOGSEG: GROWTH: FOREIGN: RESTR:

1 if the firm has a material internal control weakness; 0 otherwise. Decile rank of absolute value of discretionary accruals. Most recent three years average market value. Log of the number of years that the company has CRSP data. 1 if the sum of earnings before extraordinary items for year t and year t-1 is less than zero, 0 otherwise. Altman Z-score measure of financial distress. Log of number of operating and geographic segments. Most recent three years’ sales growth. 1 if the company has non-zero foreign currency translation in year t, 0 otherwise. Aggregate restructuring charges in year t and t-1 scaled by market capitalization in year t. 9

DGM find that material weaknesses are associated with the accrual quality of the firm. Accordingly, we expect a positive relationship between ranked discretionary accruals and ICWs. ACK find a negative relation between company size and the presence of an ICW. They argue that smaller firms are likely to have weaker internal controls since larger firms are able to invest more in their information systems and internal control. DGM also find a negative association between company age and ICWs since an older firm is more likely to have resolved any problems in their control system. The company’s financial condition is likely to impact the financial condition of the firm. Similar to DGM, we use the variable AGG_LOSS to indicate whether the sum of earnings before extraordinary items in year t and year t-1 is negative and expect this to be positively related to ICWs. ACK use the Altman (1968) Z-score measure of financial distress in their model. We expect this measure to be negatively positively related to the presence of an ICW since a higher Z-score is associated with a lower probability of bankruptcy. The complexity of the company’s operating and reporting environment also impacts the likelihood of receiving an ICW. As in DGM, we control for the log of the number of operating segments (LOGSEG) and the presence of foreign currency translations (FOREIGN). ACK argue that growth measured by the three-year growth in sales (GROWTH) is likely to be positively associated with ICWs as accounting and information systems may not keep pace with the demands placed on the system. For similar reasons, DGM argue that restructuring charges are likely to be associated with ICWs. We expect all four variables (LOGSEG, FOREIGN, GROWTH and RESTR) to be positively related to ICWs.

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Descriptive statistics for the variables, including the ICW and tax consulting variables, are included in Table 1. Approximately 13.4% of the sample had one or more ICWs. Approximately 4.8% of the sample had a tax-related ICW, and 11.4% had other ICWs. While 82% of the sample incurred tax-related service fees, the tax fees averaged 9% of the total fee. Insert Table 1 about here Table 2 includes a correlation matrix for the variables. The presence of an ICW is negatively correlated with the presence of tax consulting and the tax fee ratio. ICWs are significantly positively correlated with ranked discretionary accruals, as well as the aggregate loss indicator variable, foreign translations, and restructuring charges. ICWs are negatively correlated with size, age, and the Z-score variable. The presence of a tax ICW is significantly positively correlated with other types of ICWs. Insert Table 2 about here Before conducing empirical tests of the effects of tax consulting on ICW, we report the results of the basic regression model based on DGM and ACK to assess the fit and comparability of the model. The results of the regression are reported in Table 3. Insert Table 3 about here The first column presents the results using all ICWs as the dependent variable. The results are generally consistent with the results reported by DGM and ACK. The likelihood of receiving an internal control weakness is significantly positively associated with ranked discretionary accruals, the aggregate loss variable, and foreign translation adjustment. ICWs are significantly negatively associated with company size and the Z-Score variable.

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The second and third columns report the results of the model separately for tax ICWs and other ICWs. The results are generally consistent across the two types of ICWs. However, tax ICWs are not related to the discretionary accrual variable. This results is not surprising because other, company-level ICWs are more highly related to management discretion as reflected in discretionary accruals. This finding is consistent with the results in Doyle et al. (2007b) that company-level weaknesses are related to accrual quality, but account-specific material weaknesses are not. Tax ICWs are significantly positively related to foreign segments and restructuring charges. These more complex financial reporting areas may also result in difficulties in tax reporting.

IV. RESULTS We expand the model of internal control weaknesses to include measures of tax consulting. The first measure is a dichotomous measure of whether the auditor also provides tax consulting services to the client. The second measure is a continuous measure of the ratio of tax consulting fees to total fees. The results for this model are reported in Table 4. Insert Table 4 about here The first set of results is based on the dichotomous measure of the presence of tax consulting. Tax consulting is significantly associated with a reduced likelihood of receiving any type of ICW. In the middle column of results, we replace the tax consulting indicator variable with the continuous measure of the tax fee ratio. Again, the variable is negative and highly significant. Finally, in the last column we include both tax consulting

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variables. The continuous fee measure remains significant, but the dichotomous measure is no longer significant. These results suggest that the magnitude of the fees dominates the presence of tax consulting in affecting the likelihood of an ICW. However, the magnitude of tax consulting could reflect either greater effort, or decreased independence related to the magnitude of the fees. To attempt to disentangle these two effects, we separately address the relation between tax consulting and tax ICWs versus other types of ICWs.

Additional Tests on Tax ICWs We perform additional tests on the tax ICW sample to assess the relation between tax consulting and tax-related ICW. These tests are reported in Table 5. Insert Table 5 about here The first three sets of results report the effects of tax consulting, the tax fee ratio, and both variables in the same regression. The results are generally consistent with the results for the full sample of ICWs. The tax consulting indicator variable is not significant, even in the first column of results that excludes the tax fee ratio. The tax fee ratio is significantly negative when included by itself and when the tax consulting indicator variable is also included. This indicates the magnitude, but not the presence of tax consulting, is associated with a reduced likelihood of receiving a tax-related ICW. In the last column we include an additional variable to indicate whether the company received another ICW. Companies that receive an ICW in one area are more likely to receive an ICW in another area. More importantly, if an ICW has been reported in another area, this should diminish any lack of independence from provision of

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consulting services. The coefficient for other ICWs is positive and significant, and the tax fee ratio is no longer significant.

Additional Tests on non-Tax ICWs We perform similar tests on the non-tax ICWs sample to assess the relation between tax consulting and non-tax-related ICW. Since tax consulting should have minimal effect on other ICWs, this allows us to more directly assess whether tax consulting impacts auditor independence. These tests are reported in Table 6. Insert Table 6 about here Consistent with the results in Table 4, the tax indicator variable in the first column of results is negative and significant, and the tax fee ratio is negative and significant in the second. When both variables are included, only the tax fee ratio is significant. In the last column of results, the tax fee ratio remains significantly negative when we include an indicator for the presence of a tax-related ICW. These results suggest that tax services may negatively impact auditor independence. Kinney et al. (2004) found a negative relation between auditor-provided tax services and restatements. It is difficult to identify why tax consulting would have an overall impact on either restatements or non-tax ICWs. An alternative explanation provided by Kinney et al. (2004) is that high financial reporting quality firms also hire their audit firm to provide tax services. However, we control for discretionary accruals as a measure of financial reporting quality and still find a negative relationship between tax consulting and other ICWs.

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V. SUMMARY AND CONCLUSIONS In this study, we examine whether auditor-provided tax consulting is associated with tax-related and other ICWs. We find that tax consulting is associated with reductions in both types of ICW. When we include measures of both the presence and extent of tax consulting measured by the ratio of tax consulting to total fees, only the ratio variable is significant. This result is more consistent with a reduction in auditor independence associated with tax consulting than tax consulting improving financial reporting quality. The SEC has restricted certain type of tax services, but allows most auditorprovided tax services. These results suggest that audit committees should continue to exercise caution in selecting the auditor to provide tax-related services.

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Endnotes

1

Knowledge spillovers can also occur from auditing to consulting services. However, it

is difficult to test for the existence of such spillovers because of variation in the nature of non-audit services.

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References

Ashbaugh, H., R. LaFond and B. Mayhew. 2003. Do non-audit services compromise independence?: Further evidence. The Accounting Review 78 (July): 611-639. Ashbaugh-Skaife, H., D. Collins and W. Kinney. 2007. The discovery and reporting of internal control deficiencies prior to SOX-mandated audits. Journal of Accounting and Economics (forthcoming). Chung, H. and S. Kallapur. 2003. Client importance, non-audit services and abnormal accruals. The Accounting Review 78 (October): 931-955. Commission on Auditors’ Responsibilities (Cohen Commission). 1978. Report, Conclusions and Recommendations. New York: Commission on Auditors’ Responsibilities. Davis, L., D. Ricchiute, and G. Trompeter. 1993. Audit effort, audit fees, and the provision of non-audit services to audit clients. The Accounting Review 68 (January): 135-150. DeFond, M., K. Raghunandan and K. Subramanyam. 2002. Do non-audit services impair auditor independence? Evidence from going concern opinions. Journal of Accounting Research 40 (September): 1247-1274. Doyle, J., W. Ge. and S. McVay. 2007a. Determinants of weaknesses in internal control over financial reporting. Journal of Accounting and Economics (forthcoming). Doyle, J., W. Ge. and S. McVay. 2007b. Accruals quality and internal control over financial reporting. The Accounting Review (forthcoming). Ferguson, M., G. Seow and D. Young. 2004. Nonaudit services and earnings management: UK evidence. Contemporary Accounting Research 21 (4): 813-841. Francis, J. and B. Ke. 2002. Further evidence on non-audit services and auditor independence. University of Missouri–Columbia working paper. Frankel, R., M. Johnson, and K. Nelson. 2002. The relation between auditor’s fees for non-audit services and earnings quality. The Accounting Review (Supplement): 71105. Gleason, C. and L. Mills. 2007. Is tax estimation expense improved by using auditorprovided tax services? University of Iowa working paper. Kinney, W., Z. Palmrose and S. Scholz. 2004. Auditor independence, non-audit services, and restatements: was the U.S. government right? Journal of Accounting Research (June): 561-588.

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Leone, A., 2007. Factors related to internal control disclosure: a discussion of Ashbaugh, Collins, and Kinney (2007) and Doyle, Ge, and McVay (2007). Journal of Accounting and Economics (forthcoming). Palmrose, Z. 1986. The effect of non-audit services on the pricing of audit services. Journal of Accounting Research 24 (Autumn): 405-411. Raghunandan, K, W. Read, and S Whisenant. 2003. Initial evidence on the association between non-audit fees and restated financial statements. Accounting Horizons (September): 223-234. Reynolds, K., D. Deis, and J. Francis. 2002. Professional service fees and auditor objectivity. Louisiana State University working paper. Securities and Exchange Commission. 2000. Final Rule: Revision of the Commission’s Auditor Independence Requirements. Washington, DC: SEC. Simon, D. 1985. The audit services market: Additional empirical evidence. Auditing: A Journal of Practice & Theory 5 (Fall): 71-78. Simunic, D. 1984. Auditing, consulting and auditor independence. Journal ofAccounting Research 22 (Autumn): 679-702. Subcommittee on Reports, Accounting and Management of the Commission on Government Operations, U.S. Senate (Metcalf Committee). 1977. The Accounting Establishment: A Staff Study. Washington, D.C. Whisenant, S., S. Sankaraguruswamy, and K. Raghunandan. 2003. Evidence on the joint determination of audit and non-audit fees. Journal of Accounting Research 41 (4): 721-744.

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Table 1 Descriptive Statistics for Dependent and Independent Variables Variable ICW othICW taxICW taxFeeR1 taxcslt absdtaccrk size logage agg_loss zscore logsegments growth for_tran restructure_chg

Mean 0.134 0.114 0.048 0.090 0.822 5.499 3713.270 2.483 0.244 4.649 1.317 0.211 0.337 0.005

ICW: OTHICW: TAXICW : TAXFEER1:

Std Dev 0.341 0.317 0.213 0.099 0.383 2.872 9846.350 0.953 0.429 5.860 0.961 0.408 0.473 -0.016

Minimum 0.000 0.000 0.000 0.000 0.000 1.000 73.024 0.000 0.000 -6.698 0.000 -0.259 0.000 0.000

25th Pctl 0.000 0.000 0.000 0.012 1.000 3.000 268.691 1.946 0.000 1.585 0.000 0.042 0.000 0.000

Median 0.000 0.000 0.000 0.058 1.000 5.000 739.746 2.485 0.000 3.233 1.386 0.117 0.000 0.000

75th Pctl 0.000 0.000 0.000 0.137 1.000 8.000 2354.770 3.178 0.000 5.754 2.079 0.238 1.000 0.000

Maximum 1.000 1.000 1.000 0.642 1.000 10.000 68973.760 4.382 1.000 32.439 3.526 2.932 1.000 0.111

1 if the firm has a material internal control weakness; 0 otherwise. 1 if the firm has a material internal control weakness unrelated to tax; 0 otherwise. 1 if the firm has a material internal control weakness related to tax; 0 otherwise. Ratio of tax-related fees to total fees.

TAXCLST:

1 if tax-related fees are reported; 0 otherwise.

ABSDACCR: SIZE: LOGAGE: AGG_LOSS:

Decile rank of the absolute value of discretionary accruals. Most recent three years average market value Log of the number of years that the company has CRSP data 1 if the sum of earnings before extraordinary items for year t and year t-1 is less than zero, 0 otherwise. Altman Z-score measure of financial distress Log of number of operating and geographic segments Most recent three years’ sales growth 1 if the company has non-zero foreign currency translation in year t, 0 otherwise. Aggregate restructuring charges in year t and t-1 scaled by market capitalization in year t.

ZSCORE: LOGSEG: GROWTH: FOREIGN: RESTR:

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Table 2 Pearson Correlations for Dependent and Independent Variables (p-values are in parentheses)

ICW othICW taxICW taxFeeR1 taxcslt Abs dtaccrk

Oth ICW 0.911 (0.00)

Tax ICW 0.569 (0.00) 0.324 (0.00)

Tax FeeR1 -0.086 (0.00) -0.100 (0.00) -0.030 (0.05)

taxcslt -0.071 (0.00) -0.079 (0.00) -0.007 (0.62) 0.422 (0.00)

Abs dtaccrk 0.056 (0.00) 0.061 (0.00) 0.020 (0.20) 0.011 (0.45) 0.000 (0.98)

size -0.089 (0.00) -0.082 (0.00) -0.041 (0.01) 0.083 (0.00) 0.116 (0.00) -0.033 (0.03)

size logage agg_loss zscore Logsegments growth

logage -0.068 (0.00) -0.077 (0.00) -0.018 (0.25) 0.057 (0.00) 0.091 (0.00) -0.070 (0.00) 0.232 (0.00)

agg_ loss 0.160 (0.00) 0.155 (0.00) 0.075 (0.00) -0.107 (0.00) -0.099 (0.00) 0.144 (0.00) -0.153 (0.00) -0.223 (0.00)

zscore -0.064 (0.00) -0.060 (0.00) -0.055 (0.00) 0.036 (0.02) -0.020 (0.20) 0.030 (0.05) -0.009 (0.54) -0.073 (0.00) -0.146 (0.00)

Logseg ments 0.022 (0.14) 0.005 (0.74) 0.050 (0.00) 0.074 (0.00) 0.058 (0.00) 0.040 (0.01) 0.052 (0.00) 0.081 (0.00) -0.055 (0.00) -0.027 (0.08)

growth -0.002 (0.88) 0.011 (0.47) -0.032 (0.03) -0.033 (0.03) -0.044 (0.00) 0.122 (0.00) -0.058 (0.00) -0.163 (0.00) 0.125 (0.00) 0.092 (0.00) -0.090 (0.00)

for_tran 0.051 (0.00) 0.023 (0.13) 0.075 (0.00) 0.088 (0.00) 0.079 (0.00) 0.054 (0.00) 0.071 (0.00) 0.010 (0.49) 0.043 (0.00) 0.033 (0.03) 0.175 (0.00) -0.041 (0.01)

for_tran

See Table 1 for variable descriptions.

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restru cture_chg 0.069 (0.00) 0.048 (0.00) 0.075 (0.00) 0.025 (0.10) 0.052 (0.00) 0.014 (0.35) -0.033 (0.03) -0.060 (0.00) 0.259 (0.00) -0.156 (0.00) 0.058 (0.00) -0.109 (0.00) 0.108 (0.00)

Table 3 Logit Regressions Modeling the Probability of Internal Control Weakness ICWit = β0 + β1ABSDACCit + β2SIZEit + β3LOGAGEit + β4AGG_LOSSit + β5ZSCOREit + β6LOGSEGit + β7GROWTHit + β8FOREIGNit + β9RESTRit + εit

Variables Intercept absdtaccrk size logage agg_loss zscore logsegments growth for_tran restructure_chg Pseudo R-square # of observations

Expected Sign + + + + + +

ICW Coefficient -2.051 0.033 -0.0001 -0.071 0.711 -0.024 0.079 -0.129 0.282 1.665 7.02% 4289

Tax ICW p-value