Does internal control affect firms' use of derivatives? Evidence from China

Abstract

This study investigates the impact of internal control on firms' use of derivatives. We find that firms with strong internal controls are more likely to use derivatives than firms with weak internal controls. In cross-sectional analyses, we find that this relationship is more pronounced for subsamples with lower executive pay-performance sensitivity, lower executive ownership, smaller board size, and higher proportion of busy directors. Additional analyses suggest that among the five components of internal control, control environment, risk assessment, information & communication, and monitoring exhibit stronger impacts on derivatives use than that of control activities. We contribute to the literature on the determinants of firms' use of derivatives and highlight some components of internal control are more critical than the others in guiding a firm's derivatives usage.