The Influence Of Internal Control Quality On Executive Compensation

Since "the guidelines of internal control on listed company of Shanghai stock exchange" and "the guidelines of internal control of Shenzhen stock exchange" had been issued by Shanghai Stock Exchange and Shenzhen Stock Exchange, a series of norms have been released following, such as "the basic standard for enterprise intemal control" issued in June2008, and "enterprise internal control supporting guidelines for application" issued in April2010, thus, forming a preliminary internal control standards system. In such a context, whether enterprises are able to pay full attention to the effectiveness of internal control and its economic consequences have caused extensive discussion among academics and practitioners. Economic consequences on internal control have been widely researched at home and abroad, but most of them examine the relationship between the quality of internal control and the quality of accounting information, the impact of the quality of internal control on cost of capital, as well as the market reaction on the disclosure of material weakness in internal control, and there are few discussions on how the effectiveness of internal control affects executive compensation. However, based on the agency theory, to ensure the effectiveness of internal control is an important responsibility of management, so it should be taken into account when determining executive compensation. That is to say, internal control quality level should be reflected in the salary. As "the basic standard for enterprise internal control" and "enterprise internal control supporting guidelines for application" issued, the mechanism to establish, implement and disclose internal control has been constructed gradually, so the information about internal control becomes readily available, this further encourages enterprises to consider judging the quality of internal control in the pay-making. Based on this, this article studies the relationship between the effectiveness of internal control and executive compensation through both theoretical analysis and empirical study.In this article, we start from the agent theory, and then analysis how the quality of the internal control affects executive compensation, and give a hypothesis on this basis. Secondly, the paper select A-share listed companies in Shanghai and Shenzhen board during2011as research objects, to make a empirical study to test the hypothesis. Before that, to properly measure the quality of internal control, this paper constructs quality indicators of internal control system, based on the five elements of internal control, through scoring on these relevant indicators, and calculates the overall marks, then measure the quality of internal control according to the marks, and high marks mean high quality of internal control. In this article, executive compensation is selected as the dependent variable, the quality of internal control is the independent variable, and at the same time, variables are controlled that may affect executive compensation like corporate performance, size, ownership balancing degree and so on. There are seven exogenous variables totally. At last, a model is constructed to testing the hypothesis. Further, in consideration of the special background in our country, in this paper, samples are divided into two groups based on the nature of companies’ actual controllers, respectively called state-owned enterprise group and non-state-owned enterprise group, then carry out in regression testing again, in order to study whether there are differences existing in the relationship between the quality of internal control and executive compensation for companies that are in different property rights system,. This study shows that there is a significant positive correlation between the quality of internal control and executive compensation. And in state-owned enterprises, this positive correlation is more significant, while in the non-state-owned enterprises, this does not exist. In this paper, considering the current situation of the internal control’s implement, we analysis the reasons for these results, and put forward relevant policy recommendations.The main innovation of this paper lies in:Firstly, the existing literature about economic consequences of implementing internal control mainly focused on the relationship between internal control quality and the quality of accounting information, influence of internal control quality on capital cost and the market reaction after disclosure of material weaknesses in internal control. As the implementation of the basic standard for enterprise internal control, this paper research on the relationship between the quality of internal control and executive compensation by using data from Chinese listed companies. This riches literature on economic consequences of implementing internal control. Secondly, this paper start from carding relevant literature and theories, refer to method of measuring internal control quality including method based on weakness and method based on factors, and then construct an index system to evaluation internal control, by using principal component analysis method, at last get the internal control quality index used to measure internal control quality. This provides a useful perspective for evaluation of internal control quality.The inadequacies are reflected in:standards of internal control in our country have been widely implemented just from year2011, in the initial stage, disclosure of internal control has been imperfection, and effects of implementation of internal control on enterprises have not been obviously observed, these may do negative influence on the results of this paper.