Study On The Influence Mechanism Of Internal Control On Cost Stickiness

Cost behavior refers to the dependency relationship between the change of total costs and the change of production volume. According to the traditional cost behavior, there is a linear relationship between cost and income, which means that cost and production volume are changing within the same variation range, i.e. they are symmetric. It has showed that the cost of the company changes mechanically with the current production volume changes. The change of cost has nothing to do with the managers’ decision-making, i.e. the decisions of managers have no obvious influence on the management of cost. Therefore, managers would not perform active management on cost. However, numerous researchers have questioned the linear relationship between cost and income, because of the vital important role that managers’ decisions have played in cost management in the real work. Due to the positive cost management behavior of managers, the change of cost depends not only on the quantity of the change of the production volume, but also on the direction of that change. As a pioneer in this research field, Anderson Banker and Janakiraman came up with the word of "cost stickiness" to explain the situation that the amount increased when the production volume rises is greater than the amount decreased when the volume declines. In the financial statements of foreign enterprises, selling, general and administrative costs are presented with one number. Therefore, in this dissertation, the study put selling, general and administrative costs (hereinafter referred to as SGA) together and focused on the effect mechanism of internal control on the cost stickiness of both selling and general and administrative costs (hereinafter referred to as cost stickiness) of Chinese listed companies.Based on the historical figures of the expenses of Chinese listed companies, the total amount of SGA of A-share listed firms in Shanghai and Shenzhen increased rapidly from 63.850 billion yuan to 204.503 billion yuan between 2007 and 2014. The average proportion of cost stickiness to operating income is 16.22% during this period (2007-2014). Thus, SGA has a great impact on company’s operating performance, and cost management is an important and core part of making profits and sustaining healthy development. The research of SGA could help the owners and managers to gain a better understanding of the nature of SGA. Besides, it is also beneficial to the owners to master the reasons of cost stickiness in order to take effective measures to restrain the cost stickiness and improve business performance.In recent years, numerous financial scandals have happened. The confidence of investors, especially minority investors, has suffered a heavy blow from these scandals. And investors have lost trust in these enterprises, which led to a huge challenge to firms’ corporate finance. The United States had issued the famous Sarbanes-Oxley Act of 2002 (SOX), which made compulsory requirements for companies to strengthen internal control, in addition, managers and auditors are required to evaluate the implementation of internal control. Under this background, the Chinese Ministry of Finance has established the China Internal Control Standards Committee (CICSC) in 2006, and an internal control system was initially built up in 2010. Internal control is a process for assuring achievements of an organization’s objectives, and is implemented by the board of directors, board of supervisors, managers and staff. The internal control system is one of the factors that directly related to the cost and risk control, cost management is one of the important content of internal control, but there are only few studies of academic circles that research the relationship between the internal control system and cost stickiness. In this dissertation, we try to explore the impact of internal control on cost stickiness as well as its internal mechanism.This dissertation focuses on the research of the influence mechanism of internal control on cost stickiness, which mainly include the effects of internal control on cost stickiness and how internal control affect cost stickiness. What kind of factors that internal control uses to influence cost stickiness, direct or indirect, or a combination of both. In this dissertation, the effect of internal control on cost stickiness has been studied. Internal control has a negative influence on cost stickiness, if the internal control of a company has been well implemented, the cost stickiness would be low. Except for the relationship between internal control and cost stickiness has been researched, the influence mechanism among them has also been explored. From the perspective of agency problems, this dissertation has found an influence factor that internal control uses to affect cost stickiness, which is the managers’ self-interest behavior. Managers’ self-interest behavior is a mediation variable of the impact of internal control on cost stickiness, i.e. internal control could influence cost stickiness by impacting managers’ self-interest behavior. The use of mediating effect model is an effective way to explore whether managers’ self-interest behavior could be used by internal control to affect cost stickiness or not.According to the classic testing process of the mediation effect in the study of Baron and Kenny, this dissertation has been divided into three chapters to empirically research the relationship between internal control, managers’ self-interest behaviors, and cost stickiness. The first chapter covers an empirical study of the relationship between internal control and cost stickiness. Then, the second chapter empirically analyzes the relationship between internal control and managers’self-interest behaviors. In the third chapter, we explore the intrinsic mechanism of the influence of internal control on cost stickiness, and test whether managers’ self-interest behavior is the mediation variable of that influence or not. In this article, we collect the financial data from A-share listed companies in Shanghai and Shenzhen from 2007 to 2014 and the DIB Internal Control Index data to analyze and discuss the results of the impact of internal control on cost stickiness:Firstly, internal control can inhibit cost stickiness. Internal control is negatively related to cost stickiness. When the quality of internal control increases, cost stickiness declines. Cost management is a key component of profit management, and the process of cost management is influenced by the internal control system. Managers are encouraged to reasonably control the cost in accordance with rules and regulations, and their self-interest behaviors are monitored, which lead to the reduction of the degree of cost stickiness. Besides, the impact of internal control on cost stickiness is influenced by the ownership concentration. Internal control has not significant impact on cost stickiness when the ownership concentration is high.Secondly, the increase of the quality of internal control would lead to a decrease of managers’ self-interest behavior. It has been found that internal control is negatively related to managers’ self-interest behavior. That is the better the quality of internal control, the less the managers’ self-interest behavior. Managers’ self-interest behavior is unobservable and hardly to measure, therefore, we use the general and administrative cost ratio, total asset turnover, and managers’ remuneration to performance ratio as proxy variables of managers’ self-interest behavior in order to research the relationship between internal control and managers’ self-interest behavior. The general and administrative cost ratio represents the perks of managers, and a negative relationship between internal control and the general and administrative cost ratio has been found, which means that, internal control might reduce perks of managers. The total asset turnover represents the efficiency of management. An empirical study shows that internal control is significant positively related to total asset turnover, it also means that internal control could improve the efficiency of management and reduce managers’ self-interest behavior. Managers’ remuneration to performance ratio is used to evaluate whether managers have consistent objectives with shareholders or not. Based on an empirical research, internal control is significant positively related to the managers’ remuneration to performance ratio. It shows that internal control could improve the compensation performance sensitivity of managers, mitigate the agency problem between managers and shareholders, and restrain managers’ self-interest behaviors.Thirdly, the intrinsic mechanism of the influence of internal control on cost stickiness is internal control influencing cost stickiness by impacting managers’ self-interest behavior. Managers’ self-interest behavior is the mediation variable of the impact of internal control on cost stickiness. Managers’ self-interest behavior could generate cost stickiness, and internal control could restrain managers’ self-interest behavior, thus, managers’ self-interest behavior is one way of the impact of internal control on cost stickiness. As we mentioned before, the proxy variables of managers’ self-interest behavior are the general and administrative cost ratio, total asset turnover, and managers’ remuneration to performance ratio. From empirical analysis, it could be found that: ① when the quality of internal control increases, the general and administrative cost ratio decreases, and the cost stickiness also declines; ② the higher the quality of internal control, the higher the total asset turnover, and the lower the cost stickiness; ③ high quality of internal control would lead to a high managers’ remuneration to performance ratio, and a low cost stickiness. Managers’ self-interest behavior have played partial mediation effect, that is to say the effectiveness of internal control has directly impact on cost stickiness, but also influences the cost stickiness by impacting managers’ self-interest behavior.The innovation points and contributions that this dissertation has made are listed as follows:Firstly, the intrinsic mechanism of the effect of internal control on cost stickiness has been studied. This dissertation explored how internal control affect cost stickiness, the effect is direct or indirect, and what kind of conduct mechanism that internal control used to influence cost stickiness. From the perspective of agency problems, this dissertation has found an influence factor that internal control uses to affect cost stickiness, which is the managers’ self-interest behavior. Internal control could influence cost stickiness by impacting managers’ self-interest behavior. Secondly, this dissertation reveals the inhibition effect of internal control on cost stickiness. Internal control is a comprehensive control system, and should cover all of the company’s activities and business links, thus, cost management of the enterprise would also be influenced. This research empirically studied the effect of internal control on cost stickiness and its influence mechanism. Thirdly, the research achievements of internal control economic consequences has been enriched. Most of the prior studies about internal control economic consequences focused on their relationships with earnings quality, cost of capital, agency cost and firms’ risk, etc. This dissertation empirically studies the inhibitory effect of internal control on cost stickiness, and the scope of influence of internal control has been expanded to the level of company’s production and operation.The significances that this dissertation have been made include:Firstly, from this research, owners and managers of the companies could gain a better understanding about the nature of SGA. There is not a traditional linear relationship between SGA and production volume, their relationship has shown a characteristic of stickiness due to adjustment cost, managers’ optimistic expectation and agency problems, etc. Secondly, our empirical research could make the owners and managers to recognize the inhibitory influence of internal control on cost stickiness. The establishment of internal control could help companies to manage their costs, improve the efficiency and effectiveness of operation, and enhance the management and core competence of enterprises. Thirdly, owners of firms could gain an understanding about the intrinsic mechanism of the effect of internal control on cost stickiness from our study. Besides, they could also know the conduction effect that managers’ self-interest behavior has played to the effect of internal control on cost stickiness. Internal control could influence cost stickiness by impacting managers’ self-interest behavior. Owners of enterprises should carefully analyze the emergence reason of cost stickiness and the variation pattern of cost, which could help them improve their forecasting and decision-making about costs, and reduce the waste of cost that is caused by managers’ self-interest behavior.