Internal control and operational efficiency

• Main Authors: CHENG, Qiang, GOH, Beng Wee, KIM, Jae Bum
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2014
• Subjects: Accounting; Corporate Finance
• Online Access: https://ink.library.smu.edu.sg/soa_research/1619; https://ink.library.smu.edu.sg/context/soa_research/article/2646/viewcontent/Internal_control_and_operational_efficiency.pdf
• Institution: Singapore Management University

In this study, we examine whether and how internal control over financial reporting affects firmoperational efficiency. We find that operational efficiency, derived from the frontier analysis, issignificantly lower among firms with material weaknesses in internal control relative to firmswithout such weaknesses. We document some evidence suggesting that effective internal controlleads to greater operational efficiency through reducing the likelihood of misappropriation ofcorporate resources and through enhancing the quality of internal reports for decision making.We also document that smaller firms benefit more from having effective internal control in termsof operational efficiency. In addition, we find that the market appears to understand the effect ofineffective internal control on operational efficiency: within firms with internal control materialweakness, those with more negative market reaction experience a larger deterioration inoperational efficiency. Lastly, we find that the firms that remediate their material weaknessessubsequently experience an improvement in operating performance and stock returns, and thiseffect is mainly driven by the improvement in operational efficiency. Overall, our study extendsthe literature by presenting systematic evidence on the effects of effective internal control onoperational efficiency and firm performance.