The Impact of State Ownership and Audit Quality on the Relationship between Disclosure of Internal Control Weaknesses and Accruals Quality

Document Type : Research Paper

Authors

1 Assistant Prof., Department of Accounting, Faculty of Social Sciences and Economics, Alzahra University, Tehran, Iran.

2 MSc., Department of Accounting, Faculty of Social Sciences and Economics, Alzahra University, Tehran, Iran.

10.22059/acctgrev.2025.386683.1009055

Abstract

Objective
In the wake of high-profile financial scandals and increasing scrutiny over corporate governance, the reliability of financial reporting has become a cornerstone of investor confidence and market efficiency. Central to this reliability is the effectiveness of internal control systems, which serve as a safeguard against both intentional manipulation and unintentional errors in financial statements. Robust internal control systems play a pivotal role in safeguarding the integrity of financial reporting, particularly by constraining discretionary accounting practices that distort earnings. However, when these systems exhibit deficiencies—termed Internal Control Weaknesses (ICWs)—they may provide a pathway for opportunistic managerial behavior, ultimately undermining accrual reliability. This study investigates the empirical link between ICW disclosures and accrual quality among firms listed on the Tehran Stock Exchange (TSE), with additional attention to whether external oversight mechanisms, such as audit quality and public ownership, mitigate this effect.
 
 
Methods
The analysis is based on panel data from 277 Tehran Stock Exchange–listed firms spanning the period 2013–2022. Employing Generalized Least Squares (GLS) regression, the study accounts for heteroskedasticity and ensures statistical robustness. All classical assumptions of linear regression - linearity, normality, homoscedasticity, and absence of multicollinearity - were validated before model estimation. The study accounts for firm-specific factors such as size, performance, leverage, and industry sector to accurately assess the impact of internal controls and governance mechanisms on accrual behavior.
Results
The findings reveal a statistically significant inverse relationship between ICW disclosures and accrual quality, suggesting that firms with reported weaknesses are more prone to earnings management via accrual manipulation. This outcome supports existing theoretical frameworks that link inadequate internal controls to lower financial reporting quality. The study finds that audit quality—measured by auditor reputation, tenure, and independence—does not significantly mitigate the adverse effect of internal control weaknesses on accrual quality. Likewise, public ownership fails to function as an effective governance lever in the Iranian context, potentially due to limited managerial accountability or political entrenchment within state-influenced entities.
Conclusion
These findings offer critical insights into the dynamics of financial reporting risk in emerging markets. ICW disclosures serve as valuable signals of potential distortions in financial statements and highlight systemic vulnerabilities in internal governance structures. The observed inefficacy of both audit quality and public ownership in counterbalancing ICWs points to broader institutional limitations within Iran’s corporate oversight ecosystem. From a policy standpoint, this underscores the urgency for regulatory reforms that not only reinforce internal control protocols but also reevaluate the roles of external auditors and governmental stakeholders in promoting transparent and reliable financial reporting. Enhanced enforcement mechanisms, improved audit independence, and greater accountability in state-owned enterprises may be necessary steps to address these deficiencies. The study seeks to contribute to the growing body of literature on corporate governance and financial transparency, particularly in transitional economies where conventional oversight tools may require contextual adaptation.

Keywords

Main Subjects

References

 
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Accounting and Auditing Review
Volume 32, Issue 4
2025
Pages 757-786

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