Earnings Management, Weak Internal Controls, and Firm Size

We investigate the association between earnings management and internal control weaknesses as well as the association between earnings management and firm size. We use two samples: one from large accelerated filers, matched with the same number of firms with strong internal control, and the other from accelerated filers with internal control weaknesses, matched with the same number of firms with strong internal control. Using a modified Jones model, we determine that firms with weak internal control manage their earnings more than do those with strong internal control. The test result is robust for accelerated filers but only modest for large accelerated filers, suggesting that large firms manage their earnings less than do other firms. The results suggest that firm size is an important factor in determining earnings management. The findings are important for (1) regulators who may consider additional disclosure requirements for accelerated filers, non-accelerated filers, and smaller firms and (2) auditors who may increase their scrutiny of financial statements of these firms