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Do Internal Control Reforms Improve Earnings Quality?
Jennifer L. M. Altamuro,
The Ohio State University
Anne L. Beatty, The Ohio State University
ABSTRACT. The architects of the Sarbanes Oxley Act regulation anticipate that an improved focus on internal controls will mitigate earnings misstatements and opportunistic behavior by management, thereby improving the quality of reported earnings numbers. The proto-type for this regulation was mandated by FDICIA for banks during the early 1990s. We study the effects of FDICIA to investigate the relationship between earnings characteristics and mandated internal control reforms. We examine the impact of internal control mandates on earnings persistence, earnings’ ability to predict future cash flows, and the earnings response coefficient. We also investigate whether perceived improvements in earnings quality are driven by enhancements in internal controls, or by earnings management. Our results suggest that FDICIA-mandated internal control reforms led to improvements in each of these earnings characteristics for banks affected by the regulation relative to unaffected banks during the same period.
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