CFOs with social connections to audit committees and internal control quality

Abstract

This study examines how chief financial officers' (CFOs) social connections to the audit committee impact the quality of internal control over financial reporting (ICFR). Using restatements to identify firms with potential internal control weaknesses (ICWs) during restatement periods, we find that CFOs' social connections to the audit committee are less likely to lead to disclosure of potential ICWs; instead, they are more likely to lead to reporting of potential ICWs for irregularity restatements. Firms with CFOs' social connections to the audit committee exhibit higher financial reporting quality and reputational capital. The negative relation between the CFOs' social connections to the audit committee and disclosure of potential ICWs is more pronounced for CFOs with higher reputational capital. Overall, this research elucidates how CFOs' social connections to the audit committee can facilitate information exchange, enabling the CFO and the audit committee to effectively collaborate and monitor ICFR, which in turn diminishes the likelihood of potential ICWs occurring during restatement periods.