Research On The Association Between Internal Control And Earnings Quality And The Moderating Effect Of Ownership Structure

Recently, frequent cases of financial fraud arouses widespread concern on internal control. Reasonable assurance of the reliability of financial report is one of the main objectives of internal control. Thus, high-quality internal control should help to improve the quality of corporate’s financial report theoretically. Domestic and international scholars have conducted a lot of research on the effect of internal control on earnings quality. Among them, foreign studies have confirmed the relationship, suggesting that internal control can effectively suppress earnings management behavior and improve earnings quality. However, domestic studies do not reach the same conclusion. Thus, considering the influencing factors of internal controls in domestic studies, we test the effect of internal control on earnings quality, which was measured by accrued earnings management, real activity earnings management and earnings conservatism. Based on this test, we further test the moderating effect of ownership structure on the association between internal control quality and earnings management.Using listed companies in Shanghai and Shenzhen stock exchange in 2011 as sample, we find that high-quality internal control could improve earnings quality significantly when earnings quality are measured by accrued earnings management, real activity earnings management or earnings conservatism, and size of control right could affect the relationship between internal control and earnings quality. Nature of control right could also affect the relationship between internal control and earnings quality, except for accrued earnings management. Separation of control right and cash flow right mainly affects the relationship between internal control and accrued earnings management or earnings conservatism. What’s more, the effect on the relationship between internal control and earnings conservatism is built on absolute control of major shareholders. In addition, the separation has little effect on the relationship between internal control and real activity earnings management.The results of the theoretical and the empirical study show that, decentralizing control right moderately and avoiding the separation of control right and cash flow right could help to provide a good environment for the construction of internal control to play a better role. This study will help to further improve the construction of internal control, and provide a reference for the formation of a listed companies’ more reasonable ownership structure.