Ownership structure and internal control over financial reporting

Pao Yue-kong Library Electronic Theses Database

Ownership structure and internal control over financial reporting

 

Author: Yip, Choi-yee
Title: Ownership structure and internal control over financial reporting
Degree: D.B.A.
Year: 2010
Subject: Hong Kong Polytechnic University -- Dissertations
Financial statements
Controllership.
Industrial management.
Department: Graduate School of Business
Pages: vii, 175 leaves : ill. ; 30 cm.
InnoPac Record: http://library.polyu.edu.hk/record=b2394270
URI: http://theses.lib.polyu.edu.hk/handle/200/6008
Abstract: This study investigates the relation between a firm's ownership structure and the quality of its internal control over financial reporting. Drawing on the agency theory, this study examines the underlying factors that drive the effective implementation of an internal control system in a company. A strong internal control system exerts more control on management to restrain them from the abuse of power. As the decision to establish a strong internal control system is at the discretion of management, their inherent preference to avoid monitoring highlights the confronting stands of management and shareholders in this particular corporate decision. Their devotion to the building of a robust internal control system has therefore to be driven by some strong incentives and/or constraints. This study explores how the ownership structure, as characterized by insider ownership and institutional ownership, can influence managerial incentives and constraints in the establishment of an internal control system in a company. This study uses a sample of over 1,200 U.S. listed companies with internal control disclosures between 2004 and 2008 under the Sarbanes-Oxley Act Section 404 regulatory regime. The empirical findings of the piecewise logistic regression model suggest that insider ownership exerts a non-monotonic effect on managerial incentives, due to the interaction of alignment-of-interest and management entrenchment effects. With diffuse ownership in a company, an increase in insider ownership initially brings strong incentives for management to improve the internal control system, which will result in a lower likelihood of internal control material weaknesses. Upon reaching a certain ownership threshold, the management are getting entrenched and the likelihood of material weaknesses increases with the level of insider ownership. The entrenchment problem is alleviated when the insider ownership stake further increases. By then the domination of alignment-of-interests effect will incentivize the controlling shareholders to establish a sound internal control system, which again reduces the likelihood of internal control material weaknesses. In addition, this study shows that dominant ownership of institutional investors reduces the likelihood of internal control material weaknesses in a company. This is consistent with the argument that institutional investors are placing constraints on corporate decisions, and they are likely to monitor and pressure management to establish a strong internal control system in the company.

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