Introduction
Academics have investigated the relation between executive compensation/equity incentives and firm valuation (Himmelberg et al. 1999; Core and Guay 1999), earnings management (Cheng and Warfield 2005; Bergstresser and Philippon 2006), accounting restatements (Efendi et al. 2007), and fraud (Erickson et al. 2006). Separately, several recent studies have documented a linkage between the quality of internal control and accruals and earnings quality (Doyle et al. 2007b; Ashbaugh-Skaife et al. 2008). In this paper we examine the intersection of the two literatures by examining the association between equity incentives and material weaknesses (MWs) in internal control1 under Section 404 of the Sarbanes–Oxley Act of 2002 (SOX). The empirical question we address is whether the monetary incentives associated with equity ownership induce managers to maintain strong internal controls.