Disclosure Of Internal Control Defects In Listed Companies And Its Impact On Cost Of Capital

The disclosure of internal control information has been paid great attention bythe research of scholars due to fraud scandals and frequently happened bankruptcycases caused by low-quality internal control of listed companies worldwide and theimplementation of regulations specifically for the disclosure of internal controlinformation issued by governments. Since2011, the full implementation of China’sBasic Norms of Internal Control and its supporting guidelines progressively markedthat the disclosure of internal control information has transformed from a mandatorystage to a voluntary stage. After entering into a mandatory stage, relevant laws andregulations have compulsory requirements on the disclosure of internal controlinformation. Besides, the internal control audit has also become mandatory. Atpresent, internal control defects contained in the internal control audit and thedisclosure of internal control information have become to focus both in theoreticalfield and practical field.The disclosure of internal control defects has significant information content.Both investors and regulators are eager to have a full disclosure of internal controldefects of listed companies. However, the listed companies have the final say ofwhether to disclose internal control defects and how much to disclose. A thoroughstudy on the factors that affect the behavior of listed companies to disclose internalcontrol defects will allow investors and regulators to determine under whatcircumstances listed companies will and will not disclose internal control defects. Thepapers is based on both the five elements of internal control theory and the "ability-motivation" paradigm, systematically combing the factors affecting internal controldefects in order to form a scientific and rational logical framework. On this basis,2012Shanghai and Shenzhen A-share listed companies on the Main Board are chosen as the sample. This paper inspects the affecting factors of the disclosure of internalcontrol defects from the "existence" stage to the "discovery and disclosure" stage.Whether the disclosure of internal control defects and internal control auditaffect a company’s cost of capital directly determines the company and its investors’degree of awareness on the disclosure of internal control defects and internal controlaudit, thereby determines the transparency of information in capital market and theefficiency of resource allocation. This paper is developed at the point of institutionaltransition of the disclosure of internal control, which explores the relationshipbetween the disclosure of internal control defect information, internal control auditand cost of equity, as well as the relationship between the disclosure of internalcontrol defects, internal control audit and cost of debt respectively. During theanalysis,2011-2012Shanghai A-share listed companies are chosen as the sample. Thefindings of the study are as follows. The disclosure of internal control defectinformation will lead to the rising of cost of debt and cost of equity; Internal controlaudit will reduce cost of equity, but there’s little impact on cost of debt; Internalcontrol audit plays a distinctive regulating role on cost of equity which is affected bythe disclosure of internal control defects, but the role in regulating the impact on costof debt is not significant. The research conclusion not only increases a company’smanagement, shareholders and creditors’ awareness of the disclosure of internalcontrol defects, but also provides an empirical basis for the institutionaltransformation of the disclosure of internal control from a mandatory stage to avoluntary stage.Finally, this paper provides policy suggestions for the disclosure of internalcontrol and the disclosure of internal control defects in China through integrating theconclusion of this study and the experience of developed countries in Europe andAmerica from the perspectives of "invisible hand" and "visible hand".