Managerial Power, Internal Control And Accounting Conservatism

Internal control is a process for assuring achievement of firms’objectives, preventing managers’opportunistic behaviors and improving the quality of financial reporting. As one of the most important qualities of financial reporting, accounting conservatism has been argued to provide several governance benefits, such as reducing agency conflicts, improving managerial investment decisions, and enhancing contracting efficiency within the firm. So there is a potential link between the quality of internal control and conservative reporting. Given the importance of the environment in Chinese market, the association between internal control and accounting conservatism may be moderated by corporate internal power structure. Therefore, this study empirically tests how concentration of managerial power affects the relation between internal control and accounting conservatism using the data of Shenzhen A-share listed firms from2010to2013.The existing literatures focus on the relationship between internal control quality and accounting information quality, but rarely combine with the managerial power. Besides, to measure the quality of internal control accurately is never easy, since the listed firms reluctantly disclose the deficiency of the internal control. So, based on mandatory disclosure of internal control information, extending this stream of research by examining the relation between internal control and conservatism in consideration of concentration of managerial power really makes sense. The theoretical analysis shows that, in a firm with weak internal control, managers can readily override the control system and intentionally prepare biased financial information that impedes the timely recognition of losses and facilitates their opportunistic financial reporting objectives. What’s worse, concentration of managerial power would have a negative effect on the efficiency and effectiveness of the internal control system. Higher internal control quality is associated with better conservatism only when managerial power is dispersed inside a firm.This study finds that:(1) after controlling firms’size, litigation risk, growth option and industrial features, the listed firms produce conservative reports;(2) firms with internal control deficiencies impede the timely recognition of losses, thereby leading to lower accounting conservatism;(3) concentration of managerial power mitigates the effect of internal control on accounting conservatism. The results are robust after testing the persistence of earning changes, a measurement used by Basu (1997) as an alternative measurement of conservatism. Also, after controlling managers’ opportunistic behaviors to manipulate earnings such as "big bath", turnaround, and SEO, the results are robust.This paper provides empirical evidence about the relationship between internal control deficiencies and accounting conservatism, confirms the significance of disclosing internal control deficiencies from the perspective of financial reporting quality, and indicates that it is necessary for the regulatory authority to strengthen the regulation and supervision on the disclosure and remediation of internal control deficiencies. In addition, this paper also analyzes the influence of corporate internal power structure, which helps internal governance mechanism really takes effect in monitoring and disciplining financial reporting process and enhancing conservative and reliability of accounting information in financial statements.