Internal Control Weaknesses Selective Disclosure:Determinants And Disclosure Cost

Internal control is one of the most important means to ensure the realization of strategic goals and the safety of economic resources for the firms. Since 2008, after the promulgation of "The Basic Norms of Enterprise Internal Control" and "Enterprise Internal Control Guidelines", the internal control system of the enterprise in our country carried out a series of major reforms. As the landmark event of the above reform, the internal control information disclosure regulation has attracted wide attention in the academic community and practitioners. The system aims to regulate the company’s internal control information disclosure process to push listed firms investing more resources in their internal control construction, and finally improves the reliability of the financial information. Meantime the system provides a way for regulators and outside stake holders to gain companies’ internal control information which unfolding the black box of the firms’ internal control into the public view. Since after the implementation of the system, scholars carried out extensive research in internal control field. The present literatures mostly focus on the influence factors and economic consequences of the internal control quality and defects, validate the positive effects of good internal control quality on corporate government and harmful influence of the internal control weaknesses on the shareholders’wealth. The conclusion reveals that the internal control has great significance to improve corporate value and capital market efficiency. Therefore, present literatures greatly enriched researching field of internal control.In the internal control researching field, the related regulatory effect of system cannot be ignored. Whether the disclosure system is able to effectively regulate the economic behaviors of enterprises and does the disclosure system have negative effects on the listed firms, which reduce the whole operating efficiency of capital market. These questions have always been the core of the information disclosure field. As the key of the Internal control system, few literatures discussed the validity of its implementation. Based on the practices, after this mandatory disclosure regulation, frauds caused by deficiencies in internal control still occur. However, related early warning did not appear in the former report. Whether the internal control information disclosure regulation can improve the reliability of the financial information and act as an early warning of the company’s frauds have been questioned by the public. Actually, the process of the internal control information disclosure has three parts.Existing weaknesses, detect weaknesses and report weaknesses. Every aspect is relevant and part of the independent. Most present literatures based on the premise that reporting weaknesses means existing weaknesses and ignore the opportunistic behaviors of the listed firms. Under the absence of the post-supervision and punishment mechanism, the listed firms choose to hide the bad news or report them in some low-effective ways. That means even under the mandatory disclosure background, listed firms still have selective disclosure behaviors of internal control information. Therefore, the information disclosure cannot 100% represent the real content of the firms’ information. Combining with the existing internal control information disclosure system, exploring the influential factors and economic consequences of the internal control information’s selective disclosure behaviors has great significance.To solve these problems, based on the standard research paradigm, using the agency theory, free market theory, regulatory theory and manager incentive theory, this paper established a framework to explore the influential factors and economic consequences of the internal control information’s selective disclosure behaviors. Meantime using the companies which have financial misstatements, irregularities and financial restatement behaviors as core study sample, this paper expand main research on the following three aspects.First, this paper analyzed the current situation of the internal control information disclosure regulation’s implementation, and then examined the preliminary factors of the selective disclosure behaviors for the internal control information. It is found that after the implementation of the internal control information disclosure regulation, although the information disclosure ratio of the firms’ internal control continued to rise, the internal control quality has not been improved a lot. In terms of the effectiveness and weaknesses of internal control information, there still contained false information and contradictory phenomenon. In a further study, this paper proved the existence of the selective behaviors of internal control information. In the factors analysis, this paper proved higher level of internal governance can better alleviate the occurrence of selective disclosure behaviors of internal control information. At last, this paper used bivariate probit model to refine the process of the companies’ internal control information disclosure, the above study improved the robustness of the original conclusions.Second, based on the internal control information disclosure process, this paper analyzed what mechanism cause the selective disclosure behaviors of internal control information. Based on the theory of management entrenchment, using the listed companies with internal control deficiencies, this paper found that industry competition and power manipulation affected the behaviors of firms’ internal control deficiencies disclosure. Specifically, the existence of executive members working on the board lowdown the probability of internal control deficiencies disclosure. The phenomenon above became more obvious in the firms with high industry competition position. Further considering other industry factors, it is found that when the industry prosperity and concentration were low, the power of management manipulation was more severe.Third, this paper examined how the selective disclosure behaviors of internal control information influenced the operating cost of the firms, which contained cost of equity, cost of operating liabilities and cost of litigation risk. It is found that based on the propensity score matching sample, in accordance with the regulation requirement, the companies which disclosed their weaknesses were more likely punished by the stake holders from capital market.industry and litigation. Specifically, at the aspect of the cost of equity, based on the static and dynamic analysis, this paper showed that listed companies which truthfully disclosed internal control deficiencies undertook a higher cost of equity. That means the investors in our country’s capital market still cannot recognize the selective disclosure behaviors of internal control information. At the cost of operating liabilities, this paper showed that commercial credit which represented the operating liabilities was negatively correlated with the weaknesses disclosure. That means in spite of the information superiority, the creditors of operating liabilities still cannot recognize the selective disclosure behaviors of internal control information. In the further study, truthfully disclosing internal control deficiencies can also harm the firms’ partnership with customers. At the litigation cost aspect, lawsuits were more likely happened on the companies which previous reported their internal control weaknesses. More specifically, companies which previously reported their internal control weaknesses undertook higher probability and times of being sued and larger amount of money involved. The above phenomenon was more obvious in cases involving financial problems.The innovations of this paper are mainly reflected in the following aspects:First, this paper broke though the premise that reporting weaknesses means existing weaknesses and prove the existence of selective disclosure behaviors of internal control information. Second, different from other literature, this paper comprehensively explored the relationship between selective disclosure behaviors of internal control information and the operating cost respectively from capital market, industry and litigation risk. Last, this paper found that power manipulation was the main hinder mechanism of the internal control information disclosure which help policy makers to accurately position their regulatory direction.This article may have three academic contributions for the present internal control field:First, this paper broke the connection between disclosure behaviors and information content, and mainly focus on the information disclosure behaviors, the above researching direction expand the present studying field. Second, this paper provide evidence for evaluating the validity of internal control information disclosure regulation which carried out a new perspective for the internal control related problem. Last, this paper proves that the public disclosure information cannot 100% represent the real situation that listed firms have. The outside stake holders should evaluate the reliability of the information before using it.