Measurement of Internal Control Effectiveness


Some current research studies on internal control have revealed that beyond evaluating the effectiveness of internal controls by the traditional qualitative methods, they can also be evaluated using quantitative methods premised on empirical results (Grant, Miller, & Alali, 2008; Jokipii, 2010; Masli et al., 2010). Tseng (2007) used market value to assess the value-relevance of disclosures of internal control deficiencies,
thus complementing the literature that uses market responses to announcements of material weaknesses (Beneish et al., 2008; Hammersley et al., 2008). He used the residual income model as the market valuation model to examine the relationship between market value and firms with weak internal controls. The empirical results based on a sample of 708 firm-years with the disclosure of material weaknesses show that firms with weak, hence ineffective internal controls have lower market value. This finding, which has implications for regulators, researchers and practitioners, shows that internal control is a fundamental driver for firm-value despite remaining largely untested.

            Stoel and Muhanna (2011) using the SOX Act of 2002 to investigate empirically the relationship between IT internal control weaknesses and market value found that firms that report IT internal control weaknesses have lower market value. Hu, Qi, Liu, Zhen, and Tian (2011) found from their investigation of the value-relevance of accounting information that ineffective internal control is significantly and negatively associated with a firm’s market value.

             In keeping with previous research, the results derived by calculating the market values of banks over a selected time frame can be analyzed to determine the degree of effectiveness of their internal controls. In the proposed study, therefore, each bank’s MV shall be applied as the measure of its ICE, which is the independent variable.  


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