A comprehensive and quantitative internal control index: construction, validation, and impact

Hanwen Chen (), Wang Dong (), Hongling Han () and Nan Zhou ()
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Hanwen Chen: University of International Business and Economics
Wang Dong: Zhejiang University
Hongling Han: Zhejiang University
Nan Zhou: State University of New York at Binghamton

Review of Quantitative Finance and Accounting, 2017, vol. 49, issue 2, No 3, 337-377

Abstract: Abstract We use a new method to better measure internal control quality. Specifically, we construct an internal control index for all public firms in China, because the lack of internal control regulations during our sample period presents an interesting setting, in which the diversity of internal control quality is preserved. Two distinctive features set our index apart from the information currently available under SOX 404 in the U.S. First, it comprehensively evaluates a firm’s internal control, based on the COSO framework. Second, it quantitatively measures a firm’s internal control, using the analytic hierarchy process designed for analyzing complex decisions. We proceed to validate our index by confirming the known relation between internal control quality and earnings management. Further, we theorize that our internal control index has a positive impact on the earnings response coefficient, and find that better internal control indeed makes financial reporting more credible to investors.

Keywords: Internal control index; COSO; Analytic hierarchy process (AHP); Earnings quality; Earnings response coefficient (ERC) (search for similar items in EconPapers)
JEL-codes: C44 M42 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (11)

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DOI: 10.1007/s11156-016-0593-x

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