A Study On The Inhibition Of Internal Control On Underinvestment

Under the conditions of definitely efficient market with no agency problems, enterprises could make the most efficient investment decisions to maximize their value (hayeshi,1982). However, at the present stage, the validity of the market is very limited, and the agency problems are more prominent, non-efficient investments are very widespread. Thus, how to improve the efficiency of investment has become the research focus of enterprises and academics. Non-efficiency investments are divided into overinvestment and underinvestment, and inadequate investment is more prevalent than the excessive investment (Li Qingyuan,2009). Therefore, control the inadequate investment will be an important means to improve the investment efficiency.How to suppress the inadequate investment? The existing literatures have researched this issue from the perspectives of improve the quality of information disclosed, reduce the adverse selections, and alleviate the agency problems. However, all of the three means--improve the quality of information disclosed, reduce the adverse selections and alleviate the agency problems to control underinvestment have a certain relationship to improve the internal control quality more or less. So, whether improve the quality of internal control can also dampen the inadequate investment?The existing research literature has confirmed that the possibility of incurred insufficient investment in the enterprises with high quality of internal control is lower than in the enterprises with defects of internal control. However, on the one hand, the literature researched to curb the insufficient investment from the perspective of improve the quality of internal control is still much less, the persuasiveness is much limited; On the another hand, as the five elements of internal control have different emphasis, whether them have the same role in inhibition the insufficient investment is also worthy of further study. Therefore, this thesis will based on the angle of the five elements of internal control, enrich the existing research about the inhibition of the internal control’s quality to the underinvestment, and then further research the inhibition function of improve the quality of each element to the insufficient investment.Firstly, this thesis will review the researches about internal control and insufficient investment at home and abroad, to identify the entry point of the study and the theme of this thesis; secondly, analyze the basic theory related to the topic of this research, associate the internal control with underinvestment, establish the theoretical basis of this study, and then proposes the hypotheses of this article based on the theoretical analysis; then, create the empirical model between internal control and underinvestment, test the relationship between them by empirically; finally, summarize the conclusions and make recommendations accordingly.This thesis is divided into six parts, including introduction, literature review, theoretical foundation and research hypotheses, research design, empirical testing, conclusions and recommendations.Chapter1:Introduction. This chapter will elaborate the research background, introduce the research topic, explore the purpose and significance of the research, and describes this research method and content, as well as contributions and deficiencies.Chapter2:Literature Review. It starts with a review of the literature related to the topic of this research, including:research on the theory of the development of internal control, the economic consequences of internal control, the influencing factors on insufficient investment, the governance of insufficient investment, as well as the relationship between internal control and insufficient investment. Then summarize the development of the theory of internal control elements; sum up the three main perspectives about economic consequences on internal control:that the internal control have a positive impact on enterprise development, that the internal control have a negative impact on enterprise development, and that there was no significant relationship between the two; the study of the factors led to inadequate investment is mainly focused on the asymmetric information, agency problems and risk-averse; research about the governance of insufficient investment mainly include improving the quality of information disclosed, reducing the information asymmetry and reducing agency problems; research on the relationship between internal control and underinvestment is not deep enough; Therefore, this thesis choose to study the role of the internal control in governing the insufficient investment from the perspective of the five elements of internal control.Chapter3:Theoretical analysis and assumptions. First, introduce the basis theory about this study, including the principal-agent theory, asymmetric information theory and efficient market hypothesis. Agency problems include the agency problems between shareholders and managers, and between large shareholders and minority shareholders; asymmetric information include moral hazard and adverse selection, efficient market hypothesis includes weak form efficiency, semi-strong form efficient market and strong effective market. Second, on the basis of theoretical analysis, establish the link between internal control and underinvestment-to strengthen internal control can suppress underinvestment due to asymmetric information and agency problems, in theory. Finally, on the basis of the analysis of the relationship between the two, put forward the hypothesis of this paper. This thesis assume that improve the quality of internal control could inhibit underinvestment at first, to validate the existing research conclusions; and then put forward five sub assumptions are:improving the control environment could inhibit underinvestment; focusing on risk assessment could inhibit underinvestment; perfecting control activities could inhibit underinvestment; enhance information communication could inhibit underinvestment, and strengthening internal oversight could inhibit insufficient investment.Chapter4:Research design. First, use Richardson (2006) expected investment model to measure the degree of underinvestment, and use entropy method to calculate the internal control index; then introduce the firm size, the level of cash, debt levels, the proportion of the largest shareholder and so on as the control variables; Finally, establish the model of this study according to the theoretical assumptions and variables designed.Chapter5:Empirical Test. Firstly, using the data of A share listed companies on the main board of Shanghai Stock Exchange from2009to2011to empirically test the model (1), to select samples of insufficient investment;then use model (2) and (2a)-(2e) to test the hypotheses proposed in chapter3. The empirical test results show that:the assumption1, assumption2a, assumption2c and assumption2d have been verified, but assumption2b and assumption2e are not significant. At last, in order to test the robustness of the conclusion, this thesis separately replaces investment opportunities with Tobin’s Q, considers the systematic bias, and chooses other internal control index, and divides the samples into two groups according to the nature of the actual controller.Chapter6:Conclusions and recommendations. This chapter will summarize the conclusions of this study, and propose appropriate policy recommendations; then point out the limitations of this study and future research prospects.This study concluded:(1) China’s listed companies widespread the phenomenon of non-efficiency investments, and insufficient investment is more prevalent than excessive investment.(2) Improving the quality of internal control has a significant inhibitory effect on insufficient investment.(3) Improving the control environment, improving the control activities, and enhancing the communication of information have a distinct role in the inhibition of the insufficient investment.(4) Focusing on risk assessment and strengthening internal supervision was not significant in the inhibition of the insufficient investment, may because that:on the one hand, improving the risk assessment mechanism may be made the risk-averse managers to give up some high-risk investment projects and lead to insufficient investment; on the other hand, the effectiveness of the internal control systems of Chinese enterprises is poor, the weakness independence of internal audit department, independent directors and the Supervisory Committee bring about that the oversight functions are not fully exploited.The contributions of this thesis are:Firstly, it enriches the existing research literatures on the internal control economic consequences and the governance of insufficient investment, and enriches the application range of the theory of asymmetric information, principal-agent theory and the efficient market hypothesis.Secondly, it provides a new perspective and research ideas for future research on internal control and underinvestment. The existing literatures rarely study the relationship between internal control and underinvestment, and there was little literatures intensively study the economic consequences of the five elements of internal control. Therefore, based on the perspective of the five elements of internal control, this thesis researches the relationship between internal control and underinvestment, provides new research perspectives and research ideas for future research.Thirdly, it could help to improve the degree of enterprises’ attention on internal control, and to strengthen voluntary willingness to strengthen the internal control. Although in recent years, Chinese enterprises have been gradually strengthened internal control construction, but mainly out to meet the needs of the external audit and regulatory, companies do not really understand the importance of internal control and actively engage in the construction of internal control. The conclusions of this study can made enterprises to understand the important role of the internal control in the inhibition of insufficient investment, and enhance the enterprises to strengthen internal control construction initiative.Finally, it could provide a reference for the corporate to govern the insufficient investment. The conclusions of this study enables businesses to understand which is the most direct factor that lead to insufficient investment, so that it could enhance the pertinence in governance to the insufficient investment, and improve the efficiency and effectiveness in governance.In addition, because the author’s knowledge and ability is limited, this study has some limitations, such as:it selects only the Shanghai Stock Exchange from2009to2011A-share listed companies as the samples; there is a certain degree of subjectivity to assess the quality of internal controls; conclusions of the study is largely dependent on the reliability of enterprises’ financial reports and internal control self-assessment reports publicly disclosed; empirical test don’t subdivide insufficient investment accordance with the causes and so on.