9
Prior to Sarbanes-Oxley, many studies opted to provide indirect evidence on internal
control. Kinney and McDaniel (1989) examine characteristics of 73 firms that correct
previously reported quarterly earnings from 1976 to 1985. They posit that a restatement
implies a breach in the firm’s internal control system, and find that both firm size and firm
profitability are negatively associated with these restatements in univariate tests. DeFond
and Jiambalvo (1991) examine 41 firms with prior period adjustments from 1977 to 1988
and use firm size as a proxy for the strength of a firm’s internal controls. While firm size is
weakly negatively associated with prior period adjustments in univariate tests, they find
that firm size is not a statistically significant variable in their multivariate regression
analysis. Finally, McMullen et al. (1996) proxy for weak internal control with both SEC
enforcement actions and corrections of previously reported earnings. Their focus is on
whether weak internal control firms voluntarily report on internal control. They find that
small firms with weak internal control are less likely than other small firms to provide
voluntary reports on internal control.