Predicting Internal Control Over Financial Reporting Quality

ABSTRACT

We draw on an extensive body of research on material weaknesses (MWs) in internal control over financial reporting and employ a robust empirical approach to develop a firm‐year measure of MW likelihood, denoted I ‐score. I ‐score reflects the likely presence of a MW and captures a key dimension of financial reporting quality. We present multiple MW models and demonstrate that I ‐score effectively predicts both MWs and financial restatements. Validated across multiple time periods, our I ‐scores significantly outperform those developed by prior research and are designed for wide applicability. Our results support the usefulness of I ‐score for academic researchers, investors, auditors, regulators and other financial market participants seeking a reliable, continuous measure of MW likelihood.