Study On Governance Of Financial Frauds From Internal Controls Perspective

In the21st century, the financial frauds successively appeared at home and abroad. These frauds seriously disrupted the order of capital market and declined the confidence of investors, which have caused huge losses for stakeholders. Therefore, the United States issued SOX bill in2002requiring that the management of listed companies should be responsible for both of the reliability of financial reports and the availability of the design and the operation of internal controls. Also in Asia, the financial services agency of Japan modified the Securities Exchange Act in June2006requiring that listed companies refer self-evaluation reports of internal controls in the period end and execute the internal control auditing by independent auditors. The supervision department of China published in succession the fundamental norms of internal controls and their supporting guidelines, which constitute the framework of internal controls system. As far as is known, there lack the research on the deep relationship of the frauds and internal controls, because most researches in the theory and practice field either analyzed both of them separately or focused the cases study and the questionnaire.In actual fact, there exists close logical relationship among the prevention and management of frauds as well as the motivation analysis and the identification. The motivation analysis is the basis of the prevention and management of frauds, and the identification of frauds is used to better carry out the prevention and management. The final objective of the three closely correlated aspects is to reduce the frauds so that the reliability of financial reports can be improved.In this dissertation, firstly, the motivation, the prevention and management as well as their links to internal controls were analyzed theoretically from the perspective of the economics theory, the system foundation and the framework of the frauds motive theory and internal controls. The theoretical analysis showed that internal controls can be the most economic and effective method to prevent the frauds. Secondly, on the basis of theoretical analysis, the empirical analysis of the motivation, the prevention and management as well as their links to internal controls was done. The empirical results showed that the quality improvement of inter controls can effectively reduce the frauds. Finally, management suggests of internal controls process were put forward according to the identified motive characteristics.This dissertation is divided into seven chapters as follows. Chapter1:Introduction. This part discusses the motive of the financial frauds and the relevant economic theories of internal control, and draws a conclusion that the construction of internal control plays an important role in preventing the financial frauds.Chapter2:Literature review. By analyzing the coupling of the triangle theory of frauds and the factors of internal control, relevant research aspects are involved and analyzed such as the factors that impact the financial frauds, the quality of internal control and the accounting information, the governance of the financial frauds and the identification of the financial frauds.Chapter3:Theoretical analysis. According to the principal-agent theory, the contract theory, the relevant system background at home and abroad and the frauds motive theory, the relationship of internal controls with the prevention, identification and management was analyzed.Chapter4:The frauds motivation analysis. Listed companies punished by the supervision department from2007to2011were taken as testing samples. The risks possibly resulting in the frauds were proposed on the basis of the three-factor theory. Comparatively analyzing the data from fraud companies and non-fraud companies, the significant characteristics between the sample groups and the control groups can be obtained using the independent sample T-test, which lay the foundation of modeling the identification of financial frauds.Chapter5:Identification models of the financial frauds. This part models the identification of the financial frauds using the complementary advantages of SVM and Logistic regression analysis, and does tests to verify the generalization ability.Chapter6:The prevention of the frauds. On the basis of the identification model, the quality variables of internal controls were added while retaining original variables so as to verify the impact of internal controls with the occurrences of the frauds.Chapter7:Conclusions and policy suggestions. This part summarizes the study conclusions, proposes the targeted policy suggestions, and then gives the innovations, the limitations and the possible future researches.The conclusions by this dissertation are drawn as follows.(1)The analysis of the frauds motivation shows that there exist the following.significant differences between fraud companies and non-fraud companies.First, the fraud motives or the pressure characteristics. In the year before the year when companies make the frauds, the characteristics values such as the major business rate, the net earnings of business activities/total profit, the annual growth rate of operating revenue, the net cash flows of business activities/aggregate liabilities and the executives’ annual compensation, of the fraud companies are significantly lower than that of the non-fraud companies. But, the characteristics values, such as the negative of net cash flows, the annual growth rate of return on equity, the bankruptcy risks, the asset-liability ratio, the losses and the executives’holdings are significantly higher than that of the non-fraud companies.Second, the characteristics of the fraud opportunity. In the year when companies make the frauds, the characteristics values such as the control degree of the first big shareholder, the meeting attendance of the shareholders and the meeting attendance rate of independent directors are significantly lower than that of the non-fraud companies. But the characteristics values such as the major transactions without the review process, the frequency of shareholders’meetings, the frequency of independent directors’ meetings, the duality and the unconventional executives’changes are significantly higher than non-frauds companies.Third, the characteristics of the fraud excuses. In the three years before the year when the companies make the frauds, the characteristics values such as the auditors’changes and the non-standard auditing opinions are significantly higher than that of the non-fraud companies.(2)Conclusions of identification models of the financial frauds.First, the models by SVM can work on the data completely independent of training process to objectively and sufficiently verify the generalization ability of the classifier. As the training samples increase in the training process, the training accuracy will gradually improve as well as the generalization ability. The test results keep upon94%indicating the good performance on identification rate which is better than that of Logistic regression model keeping at87.5%.Second, the proposed models get rid of the supervision function of shareholders,independent directors and auditors which is independent of companies’internal business to do tests. The results by the models show that the control degree of the first big shareholder, the meeting attendance of the shareholders and the meeting attendance rate of independent directors and the auditing opinions have the significant properties. Ultimately, the supervision function of the shareholders, the independent directors and the auditors can effectively make up the inherent limitations of internal controls for the listed companies of China and the companies should further improve the supervision function of shareholders’meetings and the independent directors. (3)The analysis of the prevention shows that there exist a significant inverse. correlation between the quality of internal controls and the probability of the frauds.The quality of internal controls has significant impacts on the financial frauds under the condition of adding internal controls variables to the original in the identification models of the financial frauds. It is proved that the voluntary disclosure of the auditing reports of internal controls has a powerful signaling function, so the investors without professional knowledge can also take this variable as the reference index to evaluate the companies’investment risks.