Reliability of Disclosed Internal Control Weakness and Changes in Disclosure Regulation

This paper investigates whether changes in internal control weakness (ICW) disclosure regulation affect the reliability of firms' disclosed ICW under a unique Canadian setting. In Canada, public firms were required to provide internal control weakness disclosures starting in 2006. However, the credibility enhancement mechanisms (i.e., the implementation effectiveness evaluation and CEO/CFO certification) were not adopted until 2008. Taking advantage of such an evolutionary process of regulations and inferring the reliability of the disclosed ICW from the magnitude of the negative association between disclosed ICW and investment efficiency, I first document that in the pre-adoption period, the association between Canadian firms' disclosed ICW and their investment efficiency is insignificant; while in the post-adoption period, the disclosed ICW negatively affects firms' investment efficiency. This finding suggests that the credibility enhancement mechanisms improve the reliability of disclosed ICW in Canada. In addition, using the U.S. sample as a benchmark, I find that, in the post-adoption period, the association between Canadian firms' disclosed ICW and their investment efficiency is weaker, consistent with my prediction that the external audit requirement increases the reliability of the disclosed ICW. Overall, the study implies that changes in disclosure regulation lead to efficient resource allocation through improving the reliability of information disclosed.