The Impact Of Internal Control Deficiencies And The Rectification On The Cost Of Corporate Debt Capital

In recent years, a series of astonishing financial fraud scandals such as the cases of Enron, Xerox, WorldCom, Wanfu Biotechnology companies have begun to draw market participants and regulators’ attention to the internal control of company. Since the United States has launched the Sarbanes-Oxley Act in 2002, China’s financial department and other five departments have respectively released the Basic Norms of Enterprise Internal Control, Guidance for Internal Control of Enterprises in 2008 and 2010 which stipulated that all various types of companies should gradually began to implement the guidelines in order to make internal control play a positive role since 2012. Due to the publication of relevant acts, norms and guidelines, studies on internal control at home and abroad increased rapidly and more and more researchers pay attention to internal control deficiencies which as an important factor influencing internal control effectiveness. The studies on internal control deficiencies are focused on internal control deficiencies’ identification and classification, internal control deficiencies’ influential factors and the influence of internal control deficiencies on the control of earnings and audit fees. However, there is rare literature investigating internal control deficiencies’ impact on debt cost. Therefore, the present study aims to empirically explore the relationship between internal control deficiencies and debt cost, the impact of internal control deficiencies on the debt cost and the impact of diverse types of internal control deficiencies on the debt cost.First, the present study reviewed the literature on internal control deficiencies and found that there was rare study investigating the relationship between internal deficiencies and debt cost from which the present study derived. Second, after the review of the development of internal control system, the present study illustrated three classical economic theories: Principal-Agent Theory, Information-dissymmetry Theory and Signal Transmission Theory. Bases on those theories, we analyzed the effect of internal control deficiencies on the debt cost and found that internal control deficiencies could influence debt cost through the impact on accounting information quality or through influencing business efficiency which changed prospective cash flow of the company. On the ground of previous discussion, the present study put forward 4 hypotheses which were empirically examined by A-shares samples on the Shenzhen and Shanghai stock exchange from 2011 to 2013. With descriptive analysis of characteristics of each variable, correlation analysis and empirical verification of the models, we came to the following four conclusions:(1) Quality of listing companies’ internal control self-assessment report needs to be improved. Although listed companies were obliged to reveal their internal control self-assessment report under mandatory disclosure circumstance, reports were diverse and formalistic and did not truly reflect the company’s actual situation.(2) Internal control deficiencies existed in listed companies resulting in the rising of debt cost and the effects were long-term. That is, listed companies’ internal control deficiencies caused the increasing of debt cost for the subsequent years and the negative influence still existed in the fourth year since the emergence of internal control deficiencies.(3) Rectification of internal control deficiencies led to reduction of debt cost. When companies had internal control deficiencies, debt cost would significantly rise and when it had been rectified, the debt cost would decrease. However, the increasing part of the debt cost did not reduce to the same degree. Evidently, from internal control deficiencies perspective, the debt cost was sticky.(4) The influences of various types of internal control deficiencies on debt cost were different. Internal control deficiencies could be divided into general deficiencies and substantial deficiencies. Compared to the general deficiencies, the impact of substantial deficiencies on debt cost was grater. Last but not least, combined with research questions and conclusions of the study, the present study put forward relevant policy proposals from the perspective of companies and regulators. On the one hand, listed companies should strengthen internal control and improve the quality of internal control. On the other hand, regulators should strengthen supervision of the internal control and establish a sound punishment mechanism. Besides, we discussed some limitations of the present study which provided reference for the future study.To sum up, the present study investigated the influence of internal control deficiencies and rectification on debt cost in order to raise companies’ concern. The present study suggested that considering the long-term interests of companies, companies which had internal deficiencies should positively rectify and reform it and strengthen and improve the quality of internal control. At the same time, the present study expected to provide a realistic basis for supervision department to strengthen supervision internal control promote the efficient and orderly capital market operation and in turn promote a more efficient and well-organized capital market.