臺大管理論叢 NTU Management Review VOL.30 NO.2

The Benefits of Disclosing Internal Control Weaknesses: Evidence from Taiwanese Banks 176 1. Introduction The 1992 framework of the Committee of Sponsoring Organization (COSO) indicates that internal controls are designed to provide reasonable assurance regarding the achievement of objectives in the following categories: effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations. To ensure that internal control systems functioning appropriately, firms in developed countries are in general required by regulators to assess their internal control effectiveness and provide some form of disclosure regarding any deficiencies or weaknesses revealed by the assessment. Such information is usually referred to as an Internal Control Weakness (ICW) disclosure. Ogneva, Subramanyam, and Raghunandan (2007) indicate that ICWs can pertain to specific accounting issues (e.g., revenue recognition or inventory accounting) or broader control issues (e.g., adequacy and training of personnel). Hence, extant studies on ICW disclosures generally posit that disclosing ICWs have negative consequences. For example, Ashbaugh-Skaife, Collins, Kinney, and LaFond (2009) find that firms with ICWs have significantly higher idiosyncratic risk, systematic risk, and cost of equity. Dhaliwal, Hogan, Trezevant, and Wilkins (2011) show that, on average, a firm’s credit spreads on its publicly traded debt increases marginally if it discloses a material weakness. However, the direct value effect of ICW disclosures remain puzzling. Beneish, Billings, and Hodder (2008) propose that if investors already recognize that ICW-disclosing firms have higher information risk (and hence have discounted stock prices), ICW disclosures are unlikely to be incrementally informative. For firms which disclose at least one ICW, the negative announcement of abnormal returns is significant only for non-accelerated filers but not for accelerated filers. This conclusion is drawn from the fact that accelerated filers operate in richer information environments, so ICW disclosures are less likely to provide investors with incremental information. Li, Yu, Zhang, and Zheng (2016) show that firms which report ICWs have lower Tobin’s q values for the period before the disclosures are reported, indicating that the negative effect associated with ICWs is reflected in the equity value prior to the time of disclosure. This present study focuses on the value effect of disclosing ICWs by using data from banks in Taiwan. Such an investigation is crucial for at least two reasons. First, the value effect directly affects management incentives to report ICWs. Second, the requirement for