The Impact Of Internal Control On The Investment Efficiency

Investment management has always been one of the three major themes in the relevant academic research field. Many studies have been conducted from different perspectives on how to determine the optimal scale of investment for the improvement of efficiency. Investment Mainstream Finance Theory, originated by Tobin, with the assumptions of the efficient market and information symmetry, believes that corporate investment bears no relationship with financing and internal management relations, but depends on market demand. In theory, a good internal management system and high-quality internal control can reduce moral hazard at manager level, help investors and managers sift better investment projects, and eliminate the negative impact of various internal and external factors, thus enhancing business investment efficiency. Previous literature also shows that high-quality internal management system of the enterprise has a role in promoting the efficiency of investment. However, many other factors contribute to the efficiency of the enterprise investment. Internal control only involves coordination methods, procedures and measures adopted concerning enterprises’internal operation policy. With the concentration of the stock ownership, many listed companies are actually operated by "internal control". Plus the relative lack of external supervision, it becomes increasingly difficult to meet the stakeholder’s growing needs for the disclosure of internal control information. Therefore, in 2008, the Ministry of Finance issued the "Basic Norms of Internal Control" and related guidelines requiring listed companies to evaluate the validity of internal controls, and to be audited of the effectiveness of internal control by relevant institutions, so as to enhance investors’confidence and maintain a healthy and stable development of capital markets. In this context, extensive academic researches on the internal controls have been carried out, including the study of the relationship between the efficiency of the internal control and corporate investment, but rather less attention has been paid to the effect of internal control on the efficiency of corporate investment, and much work needs to be done from empirical aspects of business investment. This paper, on the basis of the previous literature, conducted an empirical study on whether the construction of the internal control system can influence decisions of managers and investors, and ultimately affect the company’s investment efficiency.In the paper, qualitative analysis based on the previous related literature was used in order to study the relationship between the efficiency of the internal control and corporate investment; quantitative analysis was also employed on the basis of logic deduction and quantitative measurement. The paper first proposed research hypotheses, and then built the relevant empirical model. It finally tested hypotheses and empirical model through the relevant data collection and analysis, which accordingly tested the relationship between internal control and investment efficiency of listed companies.This paper is divided into four sections, a total of seven chapters. The first part is the literature review which introduces the research background, significance, purpose and methods. It reviews and evaluates the previous literature at home and abroad on the internal control and the efficiency of corporate investment.The second part is the theoretical analysis. The relationship between the internal control and efficiency of corporate investment, and the internal mechanism and development trend, are deduced based on a comprehensive analysis of the enterprise inefficient investment motives. First, investment efficiency measurement model is described and evaluated by analyzing the advantages and disadvantages of various metrics, and then the effects of the elements of internal control on business investment efficiency are discussed. High-quality system of internal control of the company, by virtue of its control, supervision, incentive and restraint mechanisms can effectively inhibit or reduce the incomplete contracts, and improve the internal control of the company to ease interest conflict of stakeholders and to avoid wasting the right investment opportunities; in addition, through good interaction and communication with stakeholders, high-quality internal control system can also enhance the quality and credibility of its financial reporting, improve its capital markets information transmission speed and effectiveness, and ease information asymmetry situation of the stakeholders, thus allowing the company to get rid of cash flow problems, as well as mistakes of identifying good investments due to "moral hazard" and "adverse selection".The third part is the empirical test. In China, investment inefficiency is not uncommon in China’s listed company’s daily business activities. With the increasingly growing trend of trading frequency and scale, inefficient investment has become an important means of management and controlling shareholders against minor shareholders. Theoretically internal controls on corporate investment has a "screening" effect. In light of the "guarantee" effect of internal control on the efficiency of business investment, this part proposes a different method of evaluation and applicability of internal control. In addition, with reference to the inefficient investment degree of Richardson model measure company, linear regression models of inefficient investment respectively with internal control factors and internal control index were constructed. Linear regression model was also constructed to show the relationship among internal control, company management and inefficient investment. Moreover, empirical testing was conducted by taking selected Shanghai and Shenzhen A-share non-financial listed companies as samples.The fourth part is the conclusion and policy recommendations. This section analyzes the efficiency of investment using the theory associated with the effect of the internal control system of listed companies in China, and measures the role of the internal control system. Ways are put forward in great details to mitigate business inefficient investment and more policy recommendations were proposed from the aspects of government and company to improve internal control system and realize sustainable development of the companies and sustainable investment of the investors, furthermore to provide a theoretical basis for improving the policies of government in the context of the new normal downturn of economic growth.Based on the theoretical aspects of the relationship between the relevant internal control and corporate investment efficiency, the paper has proposed new ideas and perspectives. (1) Literature on the investment efficiency is clarified from classical economics, new-classical economics and institutional economics and the purpose theory is proposed which emphasizes the consistent objective of the internal control system and the promotion of investment efficiency and aims at deepening internal control. (2) Internal control and corporate investment efficiency are closely related. High quality internal control system must take into account the investment efficiency improvement methods, ways, means and measures. Similarly, the efficiency of investment should also be enhanced with the consideration of strengthening the internal control system; (3) Inefficient investment level can be used to evaluate the level of the internal control. Internal control actually involves coordinated approach, procedures, policies and measures adopted to improve the operational efficiency and investment efficiency is an important measure of business performance.Therefore, the empirical research of the internal control and the corporate inefficiency investment can serve as evaluating the listed company’s internal control construction level; (4) In the internally controlled state-owned holding companies, internal control is likely to be manipulated by some executives, and becomes "self-serving" behavior, so the company’s internal control system will not achieve the role of protecting the interests of investors, and consequently the inefficient investment level ranks relatively higher. As a result, in the context of the new normal downturn of economic growth, it becomes increasingly important to assess and reform the internal control system to protect investors’interests and enhance investors’confidence, which is also essential to "steady growth, structural adjustment". (5) In this paper, internal control is divided into internal control elements and internal control index, and their respective relationship with investment efficiency are tested with the empirical studies. For different property characteristics, suitable internal control evaluation methods are used which also deepens the empirical theory of internal control.Through theoretical analysis and empirical testing, main findings are as follows:First, the listed companies with a better internal control environment can win more trust of the investors, optimize the allocation of market funds, making those well-managed companies get more resources. Therefore, some managers, even with over-invested motivation, under the context of optimal allocation of resources, fail to raise adequate funds for inefficient investment.Second, the listed companies with better control activity and risk assessment are more likely to get timely and accurate information, thus getting more allocation of resources in the capital market, and winning more trust of investors and more funds for investment with better profit prospects.Third, there exists a significantly negative correlation between information communication and supervision and companies’inefficient investment. This can be interpreted by the company’s consideration of risk aversion. In order to protect the enterprise’s reputation capital and avoid legal proceedings, companies will be more careful to consider legal compliance of the investment projects and communicate more with stakeholders for the consistency of interest objectives, thus reducing investment inefficiencies. In addition, according to the regression analysis, the higher the share proportion of the controlling shareholders is, the lower the quality of corporate financial reporting is. The controlling shareholders can easily use their controlling position to grasp the absolute decision-making power of the company, and thus the lack of checks and balances of major shareholders increase the likelihood of financial fraud, which leads to more efficient investment phenomenon.Fourth, the empirical study of the company’s internal control index and its inefficient investment found that the larger the company’s internal control index was, the less the inefficient investment was. In this paper, Xie Zhihua (2009-2013)’s protection index of accounting investors was adopted to serve as a measure of internal control. Internal control evaluation index system was built mainly based on the internal control operation, internal control information disclosure and internal controls along with external supervision.Fifth, A sound corporate governance can curb inefficient investment behavior through incentive mechanism and constraint mechanism. In the management of conflicts of interest with the interests of investors and decision-making, corporate governance can effectively restrain and reduce the opportunism behavior of the management, and prompt managers to maximize shareholder’s wealth in decision-making. Therefore, this paper pointed out the internal control of listed companies plays a more important role in inhibiting the inefficient investment with the premise of other equal conditions.In conclusion, China’s listed company’s internal control exerts inhibition effect on the inefficient investment to a certain degree. Of course, the current level of internal control of listed companies in China is still not high, and the listed companies generally lack of understanding of internal controls. Less attention has been paid to the building of the internal control system so that the listed company’s internal control system can not fully exert its effect on the company’s investment decision-making process . In order to guide enterprises towards scientific and rational investment decisions and avoid investment mistakes, to improve investment efficiency, and to accelerate the internal control system of listed companies, the paper believes the following respects are of great importance.First, improve the company’s control environment, strengthen risk awareness, implement control activities, highlight information communication, and strengthen external supervision. (1) The environment control is the cornerstone for a listed company. Well-controlled environment can ensure every investment project can be successfully subjected to a rigorous screening and decision-evaluation procedures and ensure strict implementation, timely analysis and evaluation during the project running. The company should emphasize a good cultural atmosphere, and guide employees to correctly view internal control to promote a good system of "full participation, mutual supervision"; (2) The risks faced by the company is growing in the increasingly competitive market, so risk awareness should be strengthened. Risk control should be treated as an important part of internal control and risk assessment and prevention as the company’s routine management work. In the investment decision-making process, scientific and rational risk control measures should be employed to detect inefficient investment activities in investment behavior so as to minimize the loss of the company; (3) During the operation of the projects, the progress of the projects should be timely compared with the project plan; the supervision of the projects should be strengthened. Especially in those areas with high risk assessment, it is necessary to strengthen control procedures and the budget management, standardize authorization and approval system, to build and implement feedback evaluation system, and to implement internal controls; (4) Inefficient Investment of the managers, in large part, is due to their unique access to the information without disclosure to the other stakeholders. As a result, a good mechanism of information communication should be established to ease the situation of internal and external information asymmetry. The internal information disclosure and transmission system in the company’s daily operations can improve the management efficiency, and establish a good corporate image; (5) Strengthen internal and external supervision. The construction of the listed company’s internal control system should be subjected to a all-round strict supervision. Government regulation should be strengthened on the basis of the company’s daily operations of internal control supervision system.Secondly, in order to improve capital allocation efficiency of China’s capital market, internal control especially supervision against managers and major shareholders, should be strengthened to ensure the efficiency of enterprise investment objectives, and reduce inefficient investment. In developing specific policies, great emphasis should be attached on the role of the internal control systems in the company’s investments, so that all stakeholders can fully recognize the important impact of internal control on corporate investment decisions, thus strengthening supervision of the company’s investment decisions.Finally, the evaluation system of internal control should be constantly improved. A reasonable evaluation system can increase the credit of the company’s policy. Different internal control evaluation method should be employed for different policy targets to avoid inefficient investment caused by inappropriate evaluation of the internal control.