Internal Control and Management Guidance

We examine the relation between internal control quality and the accuracy of management guidance. Consistent with managers in firms with ineffective internal controls relying on erroneous internal management reports when forming guidance, we document less accurate guidance among firms reporting ineffective internal controls. This relation extends to a change analysis, and the impact of ineffective internal controls on forecast accuracy is three times larger when the weakness relates to revenues or cost of goods sold — inputs particularly relevant to forecasting earnings. We conclude that internal control quality has an economically significant effect on internal management reports and thus decisions based on these figures.

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