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Auditors’
Auditors’ internal control internal control
opinions: do they influence opinions
judgments about investments?
709
Arnold Schneider
College of Management, Georgia Institute of Technology, Received 5 November 2008
Atlanta, Georgia, USA Revised 9 May 2009
Accepted 31 May 2009

Abstract
Purpose – The purpose of this paper is to examine the impact of internal control opinions
on individuals’ judgments about investments.
Design/methodology/approach – The approach used is a behavioral experiment where
risk assessments and judgments about investments are made for four internal control opinion
scenarios.
Findings – The results indicate that the type of internal control opinion made no difference for either
risk assessments or investment decisions.
Research limitations/implications – Participants are provided with data sets that do not contain
all of the information they may acquire when they make actual investment decisions. Also, there is a
lack of real consequences for making good or poor investment decisions.
Practical implications – The type of internal control opinion has no effect on risk assessments or
investing intentions. Thus, other considerations apparently dominate internal control opinions when
making judgments about investments.
Originality/value – This is the first paper to examine whether intentions to invest might be affected
by internal control opinions.
Keywords Internal control, Auditing, Investments
Paper type Research paper

Introduction
Over the years, there have been calls for auditors to attest to clients’ internal control
effectiveness in order to deter the incidence of management fraud (Cohen
Commission, 1978; Public Oversight Board, 1993). The American Institute of
Certified Public Accountants – AICPA (1993) provided guidance to auditors
engaged to examine and report on a client’s internal controls. Some companies
indeed have voluntarily provided internal control reports attested to by auditors.
Prior to the Sarbanes-Oxley (SOX) Act of 2002, internal control disclosures were
required only in 8-K filings when companies announced a change in auditors
(Securities and Exchange Commission – SEC, 1988). For public companies, the SOX
legislation has now made internal control reporting with auditor attestation
mandatory in annual reports.
Section 404 of SOX requires public companies to make an assessment of the
effectiveness of internal controls for financial reporting. Furthermore, the company’s Managerial Auditing Journal
Vol. 24 No. 8, 2009
auditor now attests to the effectiveness of the internal controls as part of the audit pp. 709-723
engagement. The Public Company Accounting Oversight Board – PCAOB (2004, 2005) q Emerald Group Publishing Limited
0268-6902
ruled, in Auditing Standard No. 2, that to comply with Section 404, the company’s DOI 10.1108/02686900910986376
MAJ auditor must issue two opinions: one on management’s process for making its internal
24,8 control assessment and the other on the effectiveness of the company’s internal
controls. PCAOB (2007) eliminated the requirement for the first of these two opinions
when it issued Auditing Standard No. 5, which superseded Auditing Standard No. 2.
Hence, auditors now only need to opine on the effectiveness of the company’s internal
controls. This paper examines the impact of this internal control opinion on
710 individuals’ judgments about investments.
The need for a report on the effectiveness of internal controls, attested to by the
auditor, is questionable. Auditors are required to obtain an understanding of the client’s
internal controls to properly plan and conduct their audits of financial statements.
In turn, audit programs take into account the design of internal controls and the auditor’s
planned reliance on such controls. If internal control weaknesses are identified, audit
programs are modified accordingly – substantive tests are increased. The auditor’s task
is to accumulate sufficient evidence, by whatever means necessary, to provide a basis for
an opinion on the fairness of the financial statements. Auditors can issue unqualified
opinions on financial statements even if a company has material weaknesses in internal
controls. The auditor’s report provides reasonable assurance for the financial
statements, regardless of the company’s internal control effectiveness. Thus, the
reliability of audited financial statements, in terms of assurance, should not be affected
by the auditor’s opinion on internal controls.
On the other hand, regulators contend that increased scrutiny of control systems is
necessary because control weaknesses are at the heart of large-scale fraudulent financial
reporting, e.g. Enron, WorldCom, Lucent, and HealthSouth, to name a few. The KPMG
(2003) fraud surveys also consistently identify inadequate internal controls as a factor
that contributes to the occurrence of fraud. Proponents of Section 404 argue that the
reporting requirements will enhance internal control systems, e.g. control weaknesses
will be identified and remedied sooner and ongoing management involvement will result
in improved control systems (Rittenberg and Miller, 2005). Regulators assert that by
requiring internal control disclosures, the reliability of audited financial statements can
be improved – the overall financial-reporting system can be strengthened and users’
perceptions enhanced. Nicolaisen (2004), as a Chief Accountant of the SEC, remarked
that “being able to represent that an appropriate control system is in place strengthens
public confidence and encourages investment in our nation’s industries.” These
arguments suggest that even when auditors issue unqualified opinions on financial
statements, adverse opinions on internal controls may signal that although current
financial statements are fairly presented, these statements are less reliable for predicting
future financial performance. In addition, adverse internal control opinions may signal
that the underlying future operations of the firm are at greater risk because of the lack of
internal controls.
Because of the reasons for and against the relevance of internal control opinions
when auditors issue unqualified opinions on financial statements, it is unclear how
investors should react when the auditor expresses an adverse opinion or discalimer of
opinion on internal controls and a clean opinion on financial statements. Some archival
studies have examined the effect of internal control disclosures on stock prices, with
most of them finding negative market reactions to the reporting of material weaknesses
(Whisenant et al., 2003; de Franco et al., 2005; Cheng et al., 2007; Ashbaugh-Skaife et al.,
2008; Hammersley et al., 2008).
 The current study focuses on individuals’ judgments about investments rather than Auditors’
a market-oriented approach. Individual investors are important for three reasons:
internal control
(1) this portion of the investment community is significant and potentially impacts
stock prices (DeLong et al., 1991);
opinions
(2) the SEC is concerned with the welfare effects of individual investors; and
(3) an understanding of individual investor decision making is needed to develop 711
theoretical models of investment markets (Daniel et al., 1998).

This study uses an experimental approach to investigate the effects of auditors’ internal
control opinions on individuals’ judgments about investments. The use of an
experimental approach allows one to completely control the information available to
participants. The study is able to control for factors that can cause confounding in
archival studies, including concurrent information disclosure, firm-specific
characteristics, and self-selection. Archival studies (Doyle et al., 2007b;
Ashbaugh-Skaife et al., 2007) have found that most internal control weakness
disclosures are announced by weaker companies and are accompanied by restatements,
restructuring, and other bad news. Although these studies have tried to mitigate these
problems with self-selection control procedures, the controls implemented were
probably not sufficient. Using an experimental approach, on the other hand, can
overcome these problems.
This study involves four cases in which the auditor’s opinion on internal controls is
the only difference in the information presented. In all four cases, the auditor’s opinion
on the financial statements is unqualified. Even companies that receive adverse
opinions or opinion disclaimers on internal controls overwhelmingly receive
unqualified opinions on financial statements. In a study of 170 companies that
received adverse opinions on internal control effectiveness, Crawford et al. (2007) found
that all of them received unqualified audit opinions on their financial statements. The
internal control opinions manipulated are unqualified, disclaimer, adverse due to a
specific account, and adverse due to the general control environment. The manipulation
allows for the determination of whether disclaimed or adverse internal control opinions
undermine the assurance provided by an unqualified audit opinion on the financial
statements.
As Moody’s Investor Services (2006) suggests, some internal control weaknesses are
so severe that it is difficult to audit around these problems. Perhaps, investors would
believe that lesser weaknesses (e.g. ones involving specific accounts or transactions
only) could be offset by substantive testing and that only the severe weaknesses
(e.g. company-wide problems) cannot be adequately mitigated. Therefore, this study
tests the impact of both types of internal control weaknesses that may be associated with
adverse opinions. In addition, the study examines whether judgments of graduate and
continuing education students differ from those of accountants. The latter group has a
greater familiarity with internal controls and may also have different tolerances for risk.

Prior studies
No prior studies have examined the effects of auditors’ internal control opinions on
individuals’ investment decisions or intentions to invest. Various studies have
investigated issues involving the effects of internal control reports on lenders and
securities markets. These bodies of research are discussed next.
MAJ One study has examined the effects of auditors’ internal control opinions on lending
24,8 decisions. In an experiment with loan officers, Schneider and Church (2008) found that
lenders’ assessments of the risk of extending a line of credit and the probability of
extending the line of credit are negatively affected when the company receives an
adverse internal control opinion as compared to an unqualified one.
A growing body of research has been investigating the effects of internal control
712 reports in equity markets. Whisenant et al. (2003) examined the information content of
reportable events communicated by auditors in Form 8-K filings, including those
identifying internal control weaknesses. While the results revealed that disclosures about
financial statement reliability issues have information content (i.e. negative stock price
reaction), disclosures of only internal control weaknesses do not. Ashbaugh-Skaife et al.
(2007) also found no evidence of adverse market price reactions associated with internal
control weakness disclosures. In contrast, de Franco et al. (2005) provided evidence that
cumulative size-adjusted abnormal returns decreased during a three-day event window
for companies that report internal control deficiencies. Similarly, Cheng et al. (2007)
found that companies announcing material weaknesses suffered significant negative
cumulative abnormal returns over a short period surrounding the announcement date.
Also, a study by Irving (2006) revealed that stock return volatility and trading volume
exhibited a larger event period reaction to firms’ initial material weakness disclosures
relative to an adjacent non-event period and to a matched sample of control firms.
Additionally, Hammersley et al. (2008) document a significant, negative stock price
reaction to the disclosure of the most severe internal control weaknesses. Kim and Park
(2006) found that when a company discloses its internal control deficiencies, its abnormal
stock returns are negatively associated with a change in the standard deviation of the daily
stock returns, suggesting that if the disclosures reduce uncertainty in the market, then
they have a less-negative impact on the stock price. The study also provided evidence that
companies experiencing high-stock return volatilities disclose their internal control
problems early. Beneish et al. (2008) found that unaudited disclosures required by
Section 302 of SOX are associated with negative announcement abnormal returns, while
audited disclosures required by Section 404 of SOX have no impact on stock prices.
Archival findings are mixed as to the effect of internal control disclosures on the
cost of equity or debt. Results in Ashbaugh-Skaife et al. (2009) suggest that disclosures
of internal control weaknesses are associated with a higher cost of equity. Ogneva et al.
(2007) found that, after controlling for firm-specific characteristics, disclosures of
internal control weaknesses are not associated with the cost of equity. Ghosh and
Lubberink (2006) focused on the cost of debt and their results revealed that companies
reporting internal control weaknesses had lower cost of debt. Beneish et al. (2008)
found that unaudited disclosures required by Section 302 of SOX are associated with
abnormal increases in equity cost of capital, while audited disclosures required by
Section 404 of SOX have no impact on firms’ cost of capital.
A study investigating individual investors was conducted by Lopez et al. (2006).
They found that assessed stock prices for companies with an adverse opinion on the
effectiveness of internal controls are significantly less than for companies with an
unqualified opinion. Asare and Wright (2008) examined equity analysts’ beliefs and
recommendations relating to internal control reports. They found that analysts who were
given internal control reports with entity level weaknesses, relative to those given reports
with account specific weaknesses, had lower confidence in the most recent audited
financials, audit report on the financials, and internal control strength. They also had Auditors’
higher assessments of investment risk and more unfavorable stock recommendations. internal control
Shelton and Whittington (2008) found that adverse internal control opinions are associated
with investments analysts’ assessing company risk higher and internal control strength opinions
lower. The adverse opinions also resulted in a marginally significant difference in the
likelihood of recommending stock to clients. None of these studies with individual
investors or analysts had the participants make investment decisions or express 713
intentions to invest. The current study examines whether judgments about investments in
the form of intentions might be affected by internal control reports.

Hypotheses
This study tests whether the auditors’ internal control opinion has information content
for investors. Since auditors provide opinions on the financial statements, it is arguable
as to whether an audit opinion on internal controls provides additional useful
information to investors. The assurance that accompanies the auditor’s opinion on
financial statements may very well not be affected by the opinion on internal controls.
A financial statement audit provides reasonable assurance about the fairness of
financial statements regardless of the auditor’s opinion on internal controls. Hence, it
could be argued that investors may disregard internal control opinions and just focus
on the auditor’s opinion on the financial statements.
Alternatively, the presence of internal control weaknesses, along with the auditor’s
attestation of such weaknesses, may create concerns about the reliability of the financial
statements and the company’s underlying future operations, thereby increasing
investors’ uncertainty about the company. This may cause investors to discount the
level of assurance associated with audited financial statements. Consistent with this
assertion, most of the research results discussed above suggest that internal control
disclosures affect investors’ perceptions of earnings quality (Doyle et al., 2007a; Ghosh
and Lubberink, 2006; Lopez et al., 2006). Even if internal control reports do not affect
perceptions about the reliability of the current financial statements, they may send a
signal about the reliability of future financial statements.
Additional evidence suggests that financial statement users will consider internal
control reports in their decision making (D&T, E&Y, KPMG, and PwC, 2004, p. 4). Most
of the studies reviewed above relating to the stock market’s reaction to internal control
disclosures found adverse reactions (de Franco et al., 2005; Cheng et al., 2007; Irving,
2006). In the credit arena, Moody’s Investor Services (2006) inidicates that the disclosure
of material weaknesses can affect debt ratings. In the only study to examine lending
decisions, Schneider and Church (2008) found that lenders’ decisions are negatively
impacted by adverse internal control opinions as compared to unqualified ones.
In the current study, investors are expected to consider internal control reports in
assessing an investment. The investors may react differently to an adverse opinion on
internal controls (i.e. at least one material weakness exists) as compared to an
unqualified opinion (i.e. internal controls are effective). Adverse opinions on internal
controls introduce concerns as to the reliability of financial data and increase the
uncertainty associated with company, which impacts the desirability of company as an
investment. Thus, the first research hypothesis is as follows:
H1. Investors’ judgments are negatively affected by an adverse internal control
opinion as compared to an unqualified internal control opinion.
MAJ It can also be argued that more serious internal control weaknesses have a stronger
24,8 impact on investors’ judgments than less serious internal control weaknesses. Lesser
weaknesses such as ones involving specific accounts or transactions only can usually
be offset by substantive testing (Crawford et al., 2007), whereas severe weaknesses
such as ones involving the company’s overall internal control environment cannot be
adequately mitigated. Indeed, credit rating agencies (Moody’s Investor Services, 2006)
714 distinguish between these two types of internal control weaknesses, using different
approaches for each. Prior research studies (Ettredge et al., 2006; Hoitash et al., 2008;
Raghunandan and Rama, 2006) have also examined these two types of internal control
weaknesses separately. The second research hypothesis is as follows:
H2. Investors’ judgments are more negatively affected by an adverse internal
control opinion relating to the company’s overall control environment as
compared to an adverse internal control opinion relating to a specific account.
When an auditor is unable to issue an internal control opinion due to a scope limitation,
the auditor must issue a disclaimer of opinion. It is not clear whether investors would
perceive a disclaimer negatively, so the third hypothesis is framed non-directionally, as
follows:
H3. Investors’ judgments are affected differently by a disclaimer of opinion on
internal controls as compared to unqualified or adverse internal control
opinions.

Experimental task
Experimental setting
The experimental setting involves investing judgments relating to a hypothetical
company which is described in Appendix 1. Participants are given questionnaires
containing background information about the company, financial data, analyst
forecasts of earnings and recommendations, and stock prices for the past 12 months.
They are also informed that the company is audited by a Big Four certified public
accountant (CPA) firm and that the company received a clean opinion on its financial
statements. In addition, they are told that the CPA firm has issued a report on the
company’s internal controls. All questionnaires contain the same information except
for the type of internal control opinion and the name of the company, which
corresponds to the type of internal control opinion. The experimental task is to assess:
.
the risk associated with investing in the company;
.
the probability of investing in the company; and
.
the probability of retaining the investment for at least a year.

Participants
Questionnaires were distributed to two diverse groups of participants to see whether
results would be different for those who have some level of sophistication about
internal controls (accountants from CPA firms) versus those who do not (graduate
students and continuing education students taking courses in a US business school).
Furthermore, these two groups may differ as to tolerances for risk. The 100 student
participants’ average age was 27, their average amount of full-time work experience
was 3.9 years, 29 percent were female, and 59 percent had previously purchased or sold
stock relating to a personal investment. Only 6 percent characterized their most recent Auditors’
full-time work experience as being accounting/finance. The 102 accountants from internal control
29 different non-Big Four public accounting firms had an average age of 42, their
average amount of full-time work experience was 19 years, 26.5 percent were female, opinions
43.1 percent had masters degrees (or higher), and 82 percent had previously purchased
or sold stock relating to a personal investment. The number of student respondents per
experimental group ranges from 21 to 28, while for accountants the range is 22-29. 715
Experimental design – treatments
The independent variable in the study is the type of opinion on internal controls. The
four levels are Unqualified (i.e. clean), Disclaimer, Adverse-S, and Adverse-E and the
descriptions used in the questionnaires are provided in Appendix 2. The reason given for
the Disclaimer is that “there were restrictions on the auditors’ work imposed by the
circumstances.” One form of adverse opinion, Adverse-S, indicated that the control
weakness related to a specific account, namely accounts receivable. The choice of this
account is reasonable, as a study of internal control reports revealed that “sales revenue,
accounts receivable, inventory, and accounts payable experienced the most control
deficiencies” (Williams, 2005, p. 69). The more serious form of adverse opinion,
Adverse-E, indicated that the control weakness related to the overall control
environment, stating that “the company generally has a lack of consistent policies and
procedures.”

Investor assessments – dependent variables

Three dependent variables are elicited in the study. The first asks participants to assess
the level of risk, on a ten-point scale from 1 – very low risk to 10 – very high risk,
associated with investing in the common stock of the company. Since some participants
might invest in high-risk companies, two other dependent variables are included. The
second measure asks participants to assess the probability (0-100 percent) that they would
invest at least 10 percent of an endowed $1,000 in the common stock of the company. Since
different decision making criteria may be used for purchasing versus selling investments,
a third dependent variable elicits the probability (0-100 percent) that they would retain the
investment for at least one year, given that they own $1,000 of the stock.
The experimental materials were developed to avoid the situation in which
participants’ responses would cluster at either end of the response scales. After
pre-testing with business school faculty members and students who had investing
experience, the experimental materials were modified so that the company would not be
perceived as either very strong or very weak. As well, wording changes were made for
clarification.
In addition to risk and probability assessments, participants were asked to rate the
importance of various factors in making their assessments. The ratings were elicited
on a ten-point scale from 1 – no importance to 10 – very important. These ratings may
provide additional insights about their risk and probability assessments.

Results
Overall, the results for students revealed an average risk assessment of 5.59 (with very
low risk equal to 1 and very high risk equal to 10), a 31.9 percent average probability of
investing in the company’s stock, and a 57.5 percent probability of retaining
MAJ an investment in the company for at least one year. As expected, from the pre-testing, the
24,8 responses did not cluster at either end of the response scales. Breakdowns of these three
dependent variables for the four groups of student respondents are shown in Panel A of
Table I.
A one-way ANOVA was conducted for each of the three dependent variables. The
risk variable yielded an F-value of 0.49 ( p ¼ 0.69), the probability of investing in the
716 company produced an F-value of 0.74 ( p ¼ 0.53), and the probability of retaining
the investment resulted in an F-value of 1.02 ( p ¼ 0.39). Hence, neither the risk nor the
two probability assessments were statistically significant for type of internal control
opinion. Therefore, the type of internal control opinion made no difference for either the
risk or the probability assessments of these students. These ANOVAs were repeated
using data from only those students with previous investing experience and these
results appear in Panel B of Table I. Again, none of the three dependent variables were
statistically significant at the 0.05 level for type of internal control opinion. In addition,
for the full student data set as well as for the experienced investors, ANCOVAs were
conducted with participants’ age and amount of work experience as covariates. Once
again, none of the three dependent variables were statistically significant at the 0.05
level for type of internal control opinion. Hence, all of these tests indicate that neither
H1 and H2, nor H3 were supported for the student respondents.
The results for accountants revealed an average risk assessment of 6.51 (with very
low risk equal to 1 and very high risk equal to 10), a 27.9 percent average probability of
investing in the company’s stock, and a 55.8 percent probability of retaining an
investment in the company for at least one year. These figures are fairly similar to
those of the students reported earlier. Breakdowns of the three dependent variables for
the four groups of accountants are shown in Panel A of Table II.
One-way ANOVAs for the accountant data produced an F-value of 1.58 ( p ¼ 0.20)
for the risk assessment, an F-value of 0.34 ( p ¼ 0.80) for the probability of investing in
the company, and an F-value of 0.62 ( p ¼ 0.61) for the probability of retaining the
investment. As with the students, the accountant data indicated that neither the risk
nor the two probability assessments were statistically significant for type of internal

Type of internal control opinion

Student data Unqualified Disclaimer Adverse-S Adverse-E

Panel A: all students

Number of respondents 21 24 27 28
Avg. risk assessment 5.76 5.50 5.35 5.78
Avg. probability of investing 0.38 0.28 0.33 0.30
Avg. probability of retaining 0.61 0.50 0.61 0.58
Panel B: students with prior investing experience
Number of respondents 12 12 16 19
Avg. risk assessment 5.83 6.08 5.44 6.37
Avg. probability of investing 0.30 0.20 0.31 0.19
Avg. probability of retaining 0.60 0.43 0.64 0.57
Notes: Unqualified, Disclaimer, and Adverse refer to the auditor’s opinion on internal controls.
Adverse-S indicates an adverse opinion due to internal control weaknesses pertaining to a specific
Table I. account, whereas Adverse-E indicates an adverse opinion due to internal control weaknesses
Data for student groups pertaining to the company’s overall control environment
 Auditors’
Type of internal control opinion
Accountant data Unqualified Disclaimer Adverse-S Adverse-E internal control
Panel A: all accountants
opinions
Number of respondents 25 26 29 22
Avg. risk assessment 6.16 6.23 6.93 6.73
Avg. probability of investing 0.30 0.26 0.26 0.31 717
Avg. probability of retaining 0.56 0.57 0.60 0.49
Panel B: accountants with prior investing experience
Number of respondents 21 23 21 17
Avg. risk assessment 6.43 6.17 7.33 6.82
Avg. probability of investing 0.26 0.24 0.24 0.31
Avg. probability of retaining 0.55 0.58 0.57 0.51
Notes: Unqualified, Disclaimer, and Adverse refer to the auditor’s opinion on internal controls.
Adverse-S indicates an adverse opinion due to internal control weaknesses pertaining to a specific Table II.
account, whereas Adverse-E indicates an adverse opinion due to internal control weaknesses Data for accountant
pertaining to the company’s overall control environment groups

control opinion, indicating that the type of internal control opinion made no difference
for either the risk or the probability assessments. ANOVAs using data from only
those accountants who had previous investing experience also resulted in none of the
three dependent variables being statistically significant at the 0.05 level for type of
internal control opinion. These results appear in Panel B of Table II. In addition, for the
full accountant data set as well as for the experienced investors, ANCOVAs were
conducted with participants’ age and amount of work experience as covariates. Once
again, none of the three dependent variables were statistically significant at the
0.05 level for type of internal control opinion. Hence, all of these tests indicate that
neither H1 and H2, nor H3 were supported for the accountant respondents.
Respondents also rated the importance of various factors in making their
judgments, as shown in Table III (1 – no importance; 10 – very important).
Interestingly, for both students and accountants, the auditor’s opinion on internal
controls had relatively high-importance ratings – 6.4 for students and 7.5 for
accountants. However, despite these stated importance ratings, the analyses above
indicate that type of internal control report had no effect on risk assessments and
investing intentions. Thus, other considerations apparently dominate internal control
opinions when making judgments about investments.

Factor Students’ avg. rating Accountants’ avg. rating

Company description 6.7 6.9

Standard industrial classification 4.7 3.7
Use of a Big 4 CPA firm 5.3 4.3
Auditor’s opinion on financial statements 6.5 7.7
Auditor’s opinion on internal controls 6.4 7.5
Financial data 8.1 8.8
Analyst recommendation 6.1 6.2
Historical stock prices 7.4 7.3
Table III.
Notes: 1 – No importance; 10 – very important Factor importance scores
MAJ Conclusions
24,8 This study reports the results of an investigation into the effects of auditors’ internal
control reports on judgments about investments. Section 404 of SOX requires the
auditor to issue an opinion on the effectiveness of a company’s internal controls as part
of the audit engagement. The results indicated that the type of internal control opinion
made no difference for either risk assessments or probability assessments relating to
718 investments. Findings for participants who have some level of sophistication about
internal controls (accountants from CPA firms) were similar to those who do not
(graduate students and continuing education students). Differing risk tolerances
between these two groups, however, could have offset any knowledge differences.
A comparison of Tables I and II, Panel A, reveals that for each of the four types of
internal control opinion, the accountants expressed higher average risk assessments
for the investments than did the students. The same is true when comparing risk
assessments for only those with prior investing experience (Tables I and II, Panel B).
Nevertheless, for both groups, it appears that other considerations such as financial
data and historical stock prices overshadow information about the company’s internal
controls. It is possible, however, that for both students and accountants, risk tolerances
among the four internal control group participants differed and may have negated any
differences produced by the internal control opinions, yielding non-significant results
for both groups. Therefore, future research should attempt to either control or measure
risk preferences of the participants.
A major limitation of this study is that the research was conducted under one
company setting only and therefore is not necessarily generalizable to other settings.
Inasmuch as most of the archival studies cited earlier have found significant impacts of
internal control reports, the lack of significant results in this study might suggest that
a non-representative company scenario was used. Consider that the response to the
average probability of investing in the company’s stock was only 31.9 percent for
students and 27.9 percent for accountants. Perhaps, because most respondents were
not inclined to invest in the company, the internal control opinion was not relevant. For
companies in which respondents would show more inclination to invest, the internal
control opinion could possibly matter more. Therefore, future research should
investigate the impact of internal control reports with company scenarios having
alternative characteristics as to industry, competitive environment, risk, financial
performance, and management practices.
The study also examined only two cases of internal control weaknesses. Future
research can investigate whether the results of this study can be generalized to other
types of weaknesses. As well, future research can determine whether the results are
generalizable to situations where the auditor’s report on the financial statements is not
unqualified.
This study is also subject to the usual limitations of behavioral accounting
experimental research such as providing participants with data sets that do not contain
all of the information they may acquire when they make actual investment decisions or
lack of real consequences for making good or poor investment decisions. In particular,
the information provided about internal controls was not as detailed as an investor
might typically find in SEC filings. Regarding the lack of real consequences, the
participants did not actually put any capital at risk in this experiment. Future research
can go beyond examining the investing intentions done in this study by capturing
investment decisions in an experimental market setting where the participants’ Auditors’
compensation is based on the quality of their investment decisions. internal control
In conclusion, while this study did not find evidence that internal control opinions
affected investment decisions, this does not necessarily mean that internal control opinions
opinions are generally ineffective for assessing investment risks. The lack of
significance for type of internal control opinion could have been an artifact of the
conditions inherent in this study’s experimental setting. As noted above, the following 719
explanations might individually or collectively account for why internal control
opinions had no impact on investment decisions:
.
Other considerations such as financial data and historical stock prices may have
dominated the internal control opinions.
.
Risk tolerances of the respondents among the four internal control groups may
have differed so as to negate any differences caused by internal control opinions.
.
The company characteristics, which resulted in rather low-investing
probabilities, could have made the internal control opinions irrelevant.
.
The particular types of internal control weaknesses portrayed were not viewed
as serious, whereas other types of weaknesses could possibly produce an impact
for the differing internal control opinions.
.
Lack of detail on the internal control weaknesses may have contributed to the
lack of an impact on investment decisions.

Future research should examine the effects of internal control opinions in other settings
and conditions to ascertain whether investment decisions are generally affected by
internal control opinions.

References
AICPA (1993), Statement on Standards for Attestation Engagements No. 2. Reporting on an
Entity’s Internal Control Structure Over Financial Reporting, American Institute of Certified
Public Accountants, New York, NY.
Asare, S.K. and Wright, A. (2008), “Equity analysts’ reactions to type of control deficiency and
likelihood threshold in adverse control reports”, paper presented at the 2008 American
Accounting Association Annual Meeting, Sarasota, FL.
Ashbaugh-Skaife, H., Collins, D. and Kinney, W. (2007), “The discovery and reporting of
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Appendix 1.
Background information about the company in the experimental materials was as follows:
Brief description: Dolan Enterprises designs, develops, manufactures, and markets power
protection and management solutions for computer communications and electronic applications
worldwide. The company’s products include uninterruptible power supply products, direct
current-power systems, electrical surge protection devices, power conditioning products,
precision cooling equipment and associated software, services, and accessories. These products
are used with sensitive electronic devices that rely on electric utility power, including, but not

Most recent year in $ One year ago in $ Two years ago in $

Total assets 1.4b 1.3b 1.1b

Total revenues 1.4b 1.5b 1.3b
Cash flows from operations 117 m 17 m 277.9 m Table AI.
Earnings per share 0.59 0.83 1.05 Financial data
MAJ limited to, home electronics, personal computers, high-performance computer workstations,
servers, networking equipment, communications equipment, internetworking equipment, data
24,8 centers, mainframe computers, and facilities.
Standard industrial classification: electronic and other electric equipment (SIC Code 3600).
The consensus analyst forecast of earnings per share for the coming year is $0.63. The
consensus analyst recommendation for this stock is “buy.” Please note that analysts may
recommend “strong buy,” “buy,” “hold,” “sell,” or “strong sell.”
722 On the following chart (Figure A1) historical stock prices are the closing prices per month for
the past 12 months. The months are denoted t, t 2 1, t 2 2, . . . t 2 11, where month t is the last
month of the most recent fiscal year.
The closing price of the stock on the last day of the fiscal year was $14.86. The high price for
the year was $16.77 and the low price was $10.96. All stock prices are adjusted for dividends and
stock splits.

Appendix 2.
The experimental manipulations were as follows:
Unqualified opinion on internal controls (Unqualified): the company’s auditor is a Big Four
CPA firm. The company received a clean opinion audit report on its financial statements. A clean
opinion is issued when the auditor determines that financial statements present fairly the
company’s financial position and results of operations and cash flows in accordance with
prescribed standards. Also, in compliance with the Sarbanes-Oxley (SOX) Act of 2002, Crown’s
CPA firm issued a clean opinion on Crown Enterprises’ internal controls over financial reporting,
stating that the company has maintained effective internal controls.
Disclaimer of opinion on internal controls (Disclaimer): the company’s auditor is a Big Four CPA
firm. The company received a clean opinion audit report on its financial statements. A clean opinion
is issued when the auditor determines that financial statements present fairly the company’s
financial position and results of operations and cash flows in accordance with prescribed standards.
Also, in compliance with the SOX Act of 2002, Dolan’s CPA firm disclaimed an opinion (i.e. was
unable to issue an opinion) on Dolan Enterprises’ internal controls over financial reporting, stating
that there were restrictions on the auditors’ work imposed by the circumstances.
Adverse opinion on internal controls – specific account (Adverse-S): the company’s auditor is a Big
Four CPA firm. The company received a clean opinion audit report on its financial statements.
A clean opinion is issued when the auditor determines that financial statements present fairly the
company’s financial position and results of operations and cash flows in accordance with prescribed
standards. Also, in compliance with the SOX Act of 2002, Smith’s CPA firm issued an adverse
opinion on Smith Enterprises’ internal controls over financial reporting, stating that the company
had not maintained effective internal controls over its accounts receivable.

Closing price per month for the past 12 months

$25.00
Closing price
$20.00

$15.00

$10.00

Figure A1.
Historical stock prices $5.00
t-11 t-10 t-9 t-8 t-7 t-6 t-5 t-4 t-3 t-2 t-1 t
Adverse opinion on internal controls – control environment (Adverse-E): the company’s auditor is Auditors’
a Big Four CPA firm. The company received a clean opinion audit report on its financial
statements. A clean opinion is issued when the auditor determines that financial statements internal control
present fairly the company’s financial position and results of operations and cash flows in opinions
accordance with prescribed standards. Also, in compliance with the SOX Act of 2002, Eaton’s
CPA firm issued an adverse opinion on Eaton Enterprises’ internal controls over financial
reporting, stating that the company generally has a lack of consistent policies and procedures.
723
About the author
Arnold Schneider is a Professor of Accounting and the Accounting Area Coordinator at Georgia
Institute of Technology. He received a BS in Accounting from Case Western Reserve University,
a PhD from Ohio State University, and obtained a CPA Certificate in Maryland. He was formerly
an Auditor with the US Government Accountability Office. He has also held Visiting Faculty
positions at Macquarie University (Australia) and Emory University. He has co-authored a
managerial accounting textbook and has published over 50 journal articles on auditing and
cost/managerial accounting topics. He has also served on the editorial boards of several journals.
Arnold Schneider can be contacted at: arnold.schneider@mgt.gatech.edu

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