Does Prompt Compliance with the COSO 2013 Framework Signal a Commitment to a Strong Internal Control Environment?

Abstract

In this study, we investigate the determinants of compliance with the Committee of Sponsoring Organizations of the Treadway Commission (COSO) 2013 framework and whether prompt compliance provides a signal of a commitment to a strong internal control environment. COSO 2013 framework represents the biggest change to the internal control framework in more than two decades. In firms’ first fiscal year following the supersession of the COSO 1992 framework, only 91 percent of firms in our sample were in compliance with the updated COSO 2013 framework. We find that compliance with the updated framework is more likely among firms that are larger, older, more highly leveraged, less complex, that operate in more litigious industries, and that have an effective internal control environment. Controlling for potential selection bias, we next examine whether compliance with the updated framework is indicative of a higher level of control consciousness and governance as evidenced by more conservative financial reporting. Finally, we use short-window market reactions to quarterly earnings surprises to examine whether investors perceive compliance with the updated framework as an indication of the overall control consciousness and governance of the firm. We find that firms that comply with the COSO 2013 framework exhibit more conservative financial reporting and that investors react more positively to these firms’ quarterly earnings surprises following initial compliance. Importantly, these results hold among a sample of firms without reported material weaknesses in internal controls. These results provide evidence that firms can help alleviate agency costs by signaling their commitment to a strong internal control environment.