An Empirical Analysis Of The Effect Of Internal Control Quality On Financing Constrains

In a perfect capital market, external capital and internal capital can be completely replaced by each other. However, because of information asymmetry, agency costs and other problems in real market, the external financing costs will be higher than the internal financing costs, which means external financing and internal financing is no longer completely alternative. If the enterprises dried up all the fund before implementing a program which can bring them profit, or the profit is not sufficient to compensate for external financing costs, the firm is considered to be financing constrained. Even though the financial system has been gradually advanced in China these years, China’s economy is still in a transition period and the development of China’s capital market is not balanced. Current financing system is not able to fully meet the financing needs of corporations. Severe external financing problems are plaguing most companies in China. On the other hand, because China’s current legal system can not provide adequate protection for investors, the agency conflicts between the investors and the companies is difficult to effectively reconciled, resulting in the problem of financing enterprises gets more severe. Due to these two factors, financing constraints are common for Chinese enterprises. In addition, this problem will also affect the development of China’s macro-economy in a bad way. Therefore, the problem of how to ease financing constraints faced by the enterprises must be solved.Meanwhile, since2006a series of policies to instruct the construction of corporate internal control have been issued, which indicates China’s legal system of corporate internal control has formed. Chinese enterprises have made decisive progress in their construction of internal control system. The economic consequences of the internal control are very hot topics for researchers. Asymmetric information and agency problem are regarded as the main causes of financing constraints in existing literatures. Domestic and foreign research indicates that the implementation of internal control is an important way to improve corporate governance, reducing the level of information asymmetry and agency problem. In China, the polices contain improving the efficiency and effectiveness of the company as one of the objectives of internal control. Therefore, if internal control of high quality can alleviate the financing constraints in enterprises is a real problem of concern. Therefore, this paper aims to reveal the relations between the quality of internal control and financing constraints especially to reveal if internal control of high quality can alleviate the financing constraints.After the promulgation of the internal control laws, the consequences of the implementation has been studied a lot. However, articles about the impact on corporate financing are not much, which is still an emerging area of research. For rare literature has studied the relationship between internal control and financing constraints, this paper is trying to find out if corporate internal control of high quality could reduce financing constraints, using data of listed companies during2009-2011. Furthermore, the samples would be divided into two groups:state-owned listed companies and private-owned listed companies.Thus,we can study the differences of the relationship between internal control quality and financing constraints.In addition, the different degrees of marketization are concerned in this paper.What’s the difference it brings to the relationship between internal control quality and financing constraints is also studied in this paper.This paper includes six sections:The first section is an introduction of this paper. This part points out the research background and purpose, and elaborates ideas and methods used in the study. Then, it elaborates the innovative points of this article.The second section is the literature review. It reviews existing literature on financing constraints and internal control quality respectively.Furthermore, a comment about this literature reviewed is made in this section.The third section gives the theory analysis and assumptions. At first, it defines relevant conceptions, such as financing constraints and so on. Secondly, this thesis introduces causes of financing constraints including Asymmetric information Theory and Agency Theory. Thirdly, it points out the ways in which internal control quality affects the financing constraints of listed companies. Finally, on the basis of the theory analysis, it puts forward with the four research assumptions.The fourth section is design of empirical analysis. Firstly, it explains the method of sample selection and data sources. Secondly, it puts forward with proxy variables and presents the models for empirical research. The model used in this paper is an extension of cash-Cash flows financing constraint model.The fifth section is empirical testing and analysis of the results. Firstly, it presents the descriptive statistics and correlation analysis of variables conclued in the models, then, does regression tests and analyzes the results.It tells whether internal control affects financing constraints, whether property rights or levels of marketization affects the function of internal control reducing financing constraint problems. Finally, robustness of the findings is tested in three aspects and the test results show that research conclusions are robust.The last section is the conclusions and revelations. First of all, it describes the conclusions of this study. The conclusions include:Chinese enterprises generally have financing constraints, and relative to the state-owned listed companies, private-owned listed companies have greater financing constraints. Effective internal control can play a positive role in easing financing constraints, confirming the usefulness of internal control in China’s capital market. Relative to the state-owned listed companies, the effect that high-quality internal control ease financing constraints in private-owned listed companies is more significant. In the areas with high degree of marketization, the effect that high-quality internal control eases financing constraints is statistically significant, however, the effect in areas with low degree of marketization is not statistically significant. In addition, in areas with high degree of marketization, relative to the private-owned listed companies, high-quality internal control over state-owned listed companies plays a greater role to ease financing constraints; in areas with low degree of marketization, the relations between internal control and financing constraints are not statistically significant for both state-owned companies and private-owned companies. All these reflect in the transition economy under market conditions "political relations" can be substitution for high-quality internal control, while the conclusions of this study also provide a useful reference for marketization reforms. At last, based on the findings it puts forward four revelations.The innovation points of this paper can be summed up in three aspects as following:Regarding the research area, although there is some research on the relationship between internal control and the cost of capital at home and abroad currently, there is almost no research on the relationship between quality of internal control and the financing constraints, so this is a new field.Regarding the data, in the existing literature, measure standard of internal control quality is not unified, to quantify internal control quality is a major difficulty in empirical research of internal control. In this paper,it selects the result of a mature research project which gives internal control index to measure the internal control quality. It makes conclusions more persuasive.Regarding the study period, it selected the period after internal control standard was issued and regulators called on the companies to construct the system of corporate internal control. In this period, companies have stepped up the construction of a sound internal control system, so in this stage,the quality of corporate internal control system is improved to a large extent. It is available to compare the economic consequences of internal control.