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The effect of internal control regulation on earnings quality: Evidence from Germany
Nerissa C. Brown, University of Southern California
Christiane Strohm, University of Muenster
Andreas Wompener, University of Muenster
ABSTRACT. We examine the association between internal control (IC) regulation and earnings quality with specific focus on the German context. Whereas mandatory IC requirements were introduced in the US in 2002 (SOX 302, 404), mandatory requirements have been in place in Germany since 1998 (KTG). Hence, the German setting provides us with a relatively long post-regulation period for studying the effects of IC regulation. Moreover, in contrast to the US, the German regulation extends beyond controls over financial reporting and provides a clearer, more binding framework for the monitoring of ICs. Using a differences-in-differences approach with firms in several countries as a control group, we investigate whether IC regulation leads to an improvement in various measures of earnings quality. In the post-regulation period, we find that German firms experience an increase in value relevance, timely loss recognition, earnings persistence and predictability, and a decrease in earnings smoothing.
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