Directors’,Supervisors’ And Executives’ Performance Of The Internal Control

The manager has an important role in the company’s operation. Their performance of duties is related to the realization of its business goals and the interest of investors. Because of the motivation of earnings management and some other reasons, it is not reasonable to treat the financial indicators, like the accounting profit, as the merely basis for the assessment of the managers’ compensation. Some non-financial indicators can reflect the value of the company better. And they should be applied to assess the performance of managers and treated as the important basis of decision-making mechanism of salary. On the one hand, internal control can effectively guarantee the realization of business goals. On the other hand, the internal control regulations also prove that managers have certain responsibilities for the internal control. The quality of internal control can reflect the level of managers’ effort to fulfill their fiduciary responsibilities. So it can be used to assess the performance of managers and treated as an important basis of decision-making mechanism of salary. Reducing the salary prevents the occurrence of behavior that is not good to internal control. However, the empirical research about the relevance between salaries and internal control is rarely, due to the non-financial indicator is difficult to obtain. With the publishment of2002U.S. Sarbanes-Oxley and2008’s Basic Norms of Internal Control, self-assessment and disclosure of internal control is mandatory. The indicators about the quality of internal control become easy to get. So in recent years, it is common to consider this non-financial indicator as a basis of decision-making mechanism of salary.Thus, this paper mainly includes two parts-theory part and empirical part.First, the theoretical part mainly defines the duties of Directors, Supervisors and executives as:guidance, optimization and implementation separately, from the regulatory view.Second, the empirical part is mainly about the verification. We select all listed companies from Year2008to Year2012as the research objects, and use descriptive statistics, T test for different group, principal component analysis, person correlation test, OLS regression to study the following aspects:Firstly, based on the theoretical analysis and internal control regulations, we assume that if a company has internal control material weakness, its’managers will have a lower compensation. And we verify whether the Chinese enterprises’board of supervisors and the chief financial officer perform their responsibilities of internal control. Secondly, because the good corporate governance can improve the effectiveness of the company’s compensation decision, we assume that companies with higher quality of corporate governance have higher compensation sensitivity to the internal control material weakness. Lastly, we provide the hypothesis that a company with higher financial misreporting cost has higher compensation sensitivity to the internal control material weakness. What it is required to give special instruction is that we chose the executives as study subjects for their important function of implementation to verify the impacts of financial misreporting cost and corporate governance.The contribution of the article includes:this paper makes up the theory vacancy of definition about the specific internal control responsibilities and the empirical vacancy about the internal control performance through the separate definition of internal control responsibilities and the test of correlation between compensation and internal control material weakness. And we explore the methods that can improve the internal control performance on the motivation view.The specific contents and ideas are as follows:The first part is the introduction. It includes the research background, the main innovation, outlines and study methods of the article.The second part is the literature review. It includes the literature review about managers’performance, internal control and managers’compensation. This part shows the necessity and importance of this study through the literature review and summarization.The third part is the theoretical analysis. This part argues the importance and necessity to design and implement a reasonable remuneration system, which is according to the performance on the internal control. In addition we define the internal control duties of Directors, Supervisors and executives as:guidance, optimization and implementation separately, from the regulatory view. And we show the reasons to use the internal control material weakness as the alternative variable of performance of the internal control to analyze our company’s internal control performance.The fourth part is the empirical research hypothesis and design. We base on the theoretical analysis and internal control regulations to assume that if a company has internal control material weakness, its’ managers will have a lower compensation. And we verify whether the Chinese enterprises Board of Supervisors and the chief financial officer shoulder their responsibilities of internal control performance. Fourthly, we base on that good corporate governance can improve the effectiveness of the company’s compensation decision to assume that companies with higher quality of corporate governance have higher compensation sensitivity to the internal control material weakness. And we build the G Index to verify it. Lastly, we provide the hypothesis that a company with higher financial miss-reporting cost has higher compensation sensitivity to the internal control material weakness. In addition, we use the forecast number of the economic analysts and high litigation industry as the substitution variables to verify it.The fifth and sixth parts are tests and Conclusions. And we verify all of the above hypotheses through the methods of modeling, descriptive statistics, principal component analysis, correlation analysis and multiple linear regressions. Lastly, we test the research hypothesis and get the following conclusions:(1) The overall level of China’s enterprise internal control performance is lower and is ought to be improved. And the performance of internal control declines after a rising trend from Year2008to Year2012. Especially in2010, internal control performs best. We find that this phenomenon has some relevance with the publishment of internal control regulations. Therefore, we recommend that we should use the mandatory methods of disclosure and management to strengthen internal control and supervision.(2) There is a huge difference among the different industries’ internal control performance. For example, finance and insurance industries perform their duties better, while the first industry is pending to be strengthened and improved. We find that the quality of the management team is an important factor leading industry differences of internal control performance through the analysis. Then, we propose some advices to strengthen primary industry support and management. (3) The remuneration levels of Supervisory Board are relatively lower compared with the Board of Director and CFO. We believe that this is closely related to the lower overall level of the Supervisory Board of governance performance. And it also illustrates the effectiveness of the remuneration mechanism.(4)Although our managers shoulder their personal economic responsibilities of the internal control duties. The decision-making mechanism of salaries reflects the interest tendencies of the Board itself, which they may diminish their economic responsibility when the internal control material weakness appears. And the economic forecast is not fully considered.(5) A company with higher level of corporate governance and financial misreporting cost has higher compensation sensitivity to the internal control material weakness. They are easier to enhance managers’motivation to improve internal controls. And, the financial misreporting cost, like economic analyst forecasts and high litigation costs and other factors of external stress, are more pronounced in the enhancement effect compared with the level of corporate governance.According to these research findings, we propose some suggestions to strengthen the motivation of managers to perform their internal control duties, such as the establishment of the mechanism of compensation decisions that based on the performance of internal control; improvement of the corporate governance; increase of the financial misreporting cost, and so on.This paper has following innovations:Firstly, it defines the internal control responsibilities of the Board of Directors, Supervisors and CFO specifically, and they are guidance, optimization and implementation. As regards guidance, it indicates that the Board of Directors guides the general design and implement of internal control, responsible for its development direction and overall quality. Optimization means that Board of Supervisors issue opinions to internal control deficiencies, investigates phenomena such as managers’fraud, and provides ideas to improve and perfect the design and implement of internal control. Considering implementation, it implicates that managers practice specific control activities to have internal control system worked, helping to maintain operation efficiency and effectiveness. Secondly, based on the descriptive statistics of internal control weakness classified by year and industry, the paper studies the current situation of managers’ performance in internal control providing more evidence of the real status of internal control performance. Additionally, it explores the improvement of performance of internal control from the perspectives of the regulatory oversight and industry management.Thirdly, it argues the necessity and rationality of taking managers’ performance in internal control as assessment indicators for the compensation mechanism. The correlation of compensation and material internal control weakness is used to assess the implement effectiveness of compensation mechanism, based on which, the paper studies whether person in charge of internal control take the consequences associated with their performance in it.Lastly, it introduces two factors as corporate governance and the financial misreporting cost to study managers’motivation to improve internal controls. It better interprets the long-term interest equilibrium of the both sides in the theory of principal-agent and optimal remuneration contract.This paper mainly has following limitations:Firstly, it fails to validate the correlation of the performance of Directors, Supervisors, and Executives in internal control and their salary levels respectively.Secondly, it doesn’t consider the case that mangers may be dismissed for their poor internal control performance. So, the conclusions in the paper can only to some extent reflect the validity of pay mechanism in our country.Lastly, it fails to consider the items like the background of managers in the selection of factors influencing compensation for the using of the average compensation of Directors and Supervisors as the explained factor.