Material Internal Control Weaknesses And Their Remediation On Investor Confidence

The exposure of financial fraud scandals of Enron and WorldCom in the United States and Guangxia and GreenLand in China is shocking,but at the same time,it is also greatly criticized by public.The source of all these comes from the failure of internal control,which cannot play an effective function.Of course,these events are by no means the exception,and there are countless unreported cases of internal control failure.Therefore,public have to pay attention to the internal control.In order to appease the public's anger and doubts,and restore their confidence,the United States quickly passed the Sarbanes-Oxley act(SOX),which regulated the internal control of firms.Influenced by SOX Act,other countries have also issued documents on internal control regulatory norms.As an important governance mechanism,internal control can reasonably ensure the realization of financial reporting objectives and non-financial reporting objectives,which is conducive to enhancing the ability of sustainable development of firms and improving firm value.However,the existence of material weaknesses in internal control will have the opposite effect,which will then trigger investors' concerns about the prospects for future development of the firm and the possible loss of their investment.This will seriously dent investor confidence and lead to the risk that the firms may face a decline in the stock price or a rise in the cost of capital.As the main participants in the capital market,the influence of investors' actual decision-making psychology on market behavior should be paid attention to by scholars.Meanwhile,scholars cannot exclude the influencing factors of investors' decision-making psychology from the research,otherwise the theoretical research will be divorced from the actual situation.From the perspective of new theoretical research,discussing the impact of material internal control weaknesses on investor confidence can not only effectively solve the practical problem of how to stabilize or improve investor confidence,but also help to promote the improvement of internal control quality of firms,which has both theoretical and practical significance.This paper examines the relationship between material internal control weaknesses and investor confidence by taking all companies listed in A-share of Shanghai and Shenzhen main board from 2012 to 2016 as research samples.The research found that:(1)The worse the quality of internal control is,the weaker the investor confidence is,that is,the material weaknesses of internal control are negatively correlated with the investor confidence;(2)Further classify the material weaknesses as account-level material weaknesses and company-level material weaknesses.When firms disclose material weaknesses at company-level,the decline of investor confidence is greater;(3)After the firm remediates the material internal control weaknesse,the investor confidence obtains the obvious enhancement;(4)The moderating effect of audit opinions on financial statements is not obvious,that is,the disclosure of standard unqualified audit opinions cannot significantly weaken the negative impact of material internal control weaknesses on investor confidence.These results show that the disclosure of material weaknesses in internal control is an important factor affecting investor confidence,and investors show insufficient confidence in firms with material weaknesses of internal control.The remediation of material weaknesses is good news for investors,who will revise their original expectations,thus significantly improving investor confidence.After the robustness test,the conclusion of this paper is still valid.The contribution of this paper is:(1)It can provide empirical evidence for a better understanding of the mechanism of the material internal control weaknesses on investor confidence,and enrich the theory of internal control in influencing investors' decision-making psychology;(2)It can provide some enlightenment for regulators,firms and investors.