Material Control Weakness Corrections: The Enduring Effects of Trust in Management

ABSTRACT: We examine whether investors alter their assessments of investment risk in response to corrections of material control weaknesses and the nature of the original disclosure of the weaknesses. Rose et al. (2010) find that the effect of the pervasiveness of control weaknesses is moderated by the extent of disclosure such that more detailed disclosure mitigates (exacerbates) the negative effect of more (less) pervasive weaknesses. They also conclude that trust in management is an underlying cause of this effect because high levels of disclosure for non-pervasive weaknesses are viewed as attempts to disguise bad news, while high levels of disclosure for pervasive weaknesses are viewed as honest. Based upon the findings from an experiment, we find evidence to indicate that the form of control weakness disclosures creates enduring effects on investors, even after remediation of control weaknesses. Our results indicate that the effects of trust persist after control weaknesses are remediated.