An Empirical Research On The Relationship Between Internal Control Indexes And Financial Distress

The market competition is becoming increasingly fierce, the market environment is becoming complicated and changeable, as well as the unceasing change of macro and micro factors make the enterprise generate some business risk and financial risk in the process of operation. These may cause the enterprise to fall into financial distress. Enron’s financial fraud incident, the financial scandals of World Com and Xerox Corporation, the financial fraud of Guangxia(Yinchuan) Company, Sanlu milk powder incident and the event of Green--Land make people realize that the weak internal control is the main reason for financial distress even financial fraud. With the promulgation of Sarbanes Oxley Act, Other countries in the world have also enacted the similar regulations to strengthen the construction of enterprise internal control. Our government published “The basic standard for enterprise internal control” and “The supporting guidelines for enterprise internal control,symbolizing the system of China internal control is basically completed. Shenzhen DIB Enterprise Risk Management Technology Co, Ltd constructs the internal control indexes which are based on the five factors and achieving objectives of internal control. The Ministry of finance research group, based on the achieving objectives of internal control, to construct the internal control indexes. These fill up the vacancy of the quantitative evaluation of the effectiveness of internal control in China, providing data supporting for us to study the relativity between internal control indexes and financial distress and also providing a basis for the regulatory authorities to understand the effectiveness of the internal control of the Listed Corporation.Most Previous studies on financial distress began from prediction; they selected the financial indexes to predict the financial distress. This paper introduces the non-financial indexes---internal control indexes, to study the relationship between internal control indexes and financial distress. First of all, the paper reviews the relevant literature and theories about internal control index, financial distress prediction and the relationship between internal control indexes and financial distress, analyses the influence of the five factors of internal control on financial distress in theory, then proposes the hypotheses of this paper. According to the relevant provisions of the Special Treatment System, this paper selects 92 companies of A shares from Shenzhen Stock Exchange and Shanghai Stock Exchange as the research samples which are first special treatment from 2010 to 2014, then selects five healthy companies as paired samples for each a ST company, regards the internal control information disclosure index and the five factors indexes issued by DIB as the independent variables, selects data of t year, which are analyzed by logistic regression, then to test the correlation between the indexes and financial distress. By means of descriptive analysis, correlation analysis, Co linearity test and Logistic regression, the significant relationship of internal control index, the five factors indexes and financial distress are studied. The results show that the internal control indexes and the financial distress have a significant negative correlation. The greater the internal control index is, the less likely the enterprise is in financial distress. When returning the five factor indexes of internal control and financial distress, the internal environment index, the control activity index and the supervision index pass the significant test, risk evaluation index and information and communication index had no significant impact on financial distress. This paper tries to analyze the possible reasons, may be because a part of the Listed Corporations’ risk evaluation index and information and communication index’s scores are 0, indicating that these Listed Corporations have yet to establish an effective risk assessment system and information and communication mechanism, So when returning the five factor indexes and financial distress, the indexes do not have a clear distinction. Then to return the five elements indexes of internal control and financial distress respectively, only risk evaluation index doesn’t pass the significant test. This paper also tries to analyze the possible reasons, mainly because the work of risk evaluation of the Listed Corporations are still in initial stage, the prevention, supervision and management of major risk is still a big problem. Many companies’ measures to deal with major risk are only general improvement management, there are no specific solutions. At the same time, this paper also empirically tests the relativity between internal control indexes and financial distress with data of t-1 year and t-3 year; the results show that the data of t year’s relativity are strongest. Finally, this paper proposes some suggestion from the internal control information disclosure of the Listed Corporation and the improvement of the internal control in order to perfect internal control and avoid financial distress. Relevant departments should standard the internal control information disclosure of the Listed Corporation, making different companies’ internal control evaluation reports have comparability; The Listed Corporation should fully disclose the implementation of internal control according to relevant regulations. Enterprise management should strengthen the risk awareness, improve the internal control system based on risk management, enact reasonable evaluation standard of risk management, construct the mechanism of risk investigation and classify the significant potential risks. The enterprises should formulate the internal and external information management policies, implement horizontal and vertical communication and establish a sound external communication system. The enterprises should construct perfect corporate governance structure and incentive mechanism and explicit responsibilities. The enterprises should strengthen the control of all aspects including investment, financing and production operations. The enterprises should implement a strict supervision system and disclose the financial and non-financial information of enterprises.