Internal Control Quality and the Excess Value of Diversification

This study examines the relation between internal control quality and excess value of diversification. I argue that the quality of internal controls for a diversified firm can influence its excess value of diversification, both directly and indirectly. With respect to direct effect, new disclosures on the quality of internal controls provide a direct signal of high-quality financial information that increases shareholders to monitor management, leading to higher valuation effect. Moreover, internal control quality, by providing accurate internal reports about the individual divisions for management to efficiently allocate internal capital across divisions, has an effect on firms’ internal decisions, thus contributing to an indirect effect on the valuation of diversification. Using a sample of firms that disclose material weaknesses in internal controls under the Sarbanes-Oxley Act (SOX), I predict a positive relation between internal control quality and excess value of diversification.

Project ID:PF10107-1562
External Project ID:NSC101-2410-H182-008