Are Material Weaknesses in Internal Controls Associated with Poor M&A Decisions? Evidence from Goodwill Impairment

Posted: 21 Feb 2017 Last revised: 5 Jan 2022

See all articles by Dennis Caplan

Dennis Caplan

University at Albany (SUNY)

Saurav K. Dutta

State University of New York (SUNY) at Albany

Alfred Z. Liu

University at Albany, SUNY

Date Written: February 15, 2017

Abstract

This paper examines the effect of the quality of a firm’s internal control over financial reporting (ICFR) on the quality of corporate M&A decisions. We use material weaknesses in internal control (ICMWs) from SOX 404 audits as a proxy for the quality of a firm’s ICFR, and use future goodwill impairment to proxy for the quality of managers’ M&A decisions. We find that goodwill recognized from acquisitions in years concurrent with ICMW has a greater rate of impairment in subsequent years than goodwill recognized from acquisitions in years without ICMW, thereby establishing a link between ICMW and goodwill impairment. We further show that disclosure and remediation of ICMWs appear to improve valuations of subsequent acquisitions. Our study contributes to the literature on internal controls by documenting unanticipated benefits of SOX 404 audits on managerial performance, and to the goodwill literature by identifying ICMW as a determinant of goodwill impairment.

Keywords: internal control, material weaknesses, SOX 404, goodwill impairment, mergers and acquisitions

JEL Classification: M41, M42, G38

Suggested Citation

Caplan, Dennis and Dutta, Saurav K. and Liu, Alfred, Are Material Weaknesses in Internal Controls Associated with Poor M&A Decisions? Evidence from Goodwill Impairment (February 15, 2017). Auditing: A Journal of Practice & Theory, 37(4), 49-74., Available at SSRN: https://ssrn.com/abstract=2919123

Dennis Caplan

University at Albany (SUNY) ( email )

1400 Washington Ave
Albany, NY 12222
United States

Saurav K. Dutta

State University of New York (SUNY) at Albany ( email )

135 Western Ave
Building, Room 109
Albany, NY 12222
United States

Alfred Liu (Contact Author)

University at Albany, SUNY ( email )

Albany, NY 12222
United States

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