The bomb-crater effect of CSRC random inspections: evidence from internal control quality

To optimise the regulatory approach, the China Securities Regulatory Commission (CSRC) introduced the double‐random inspection policy (DRIP), which mandates that the provincial branches of the CSRC randomly select at least 5% of local listed firms each year and randomly assign inspectors to conduct on‐site inspections of their information disclosure and corporate governance practices. This paper investigates the real effect of the DRIP on corporate financial fraud. Performing a multi‐period synthetic difference‐in‐differences model (SDID), we first find that the random inspections of CSRC have a positive causal effect on the probability of exposing corporate financial fraud. Furthermore, our heterogeneity analysis reveals that this effect is more pronounced for private firms and firms with poor accounting information quality. We then delve into the mechanisms through which random inspections affect corporate financial fraud. Our findings suggest that random inspections influence corporate behaviour by increasing media and investor attention, as well as prompting the issuance of inquiry letters by stock exchanges. Finally, we examine the economic consequences of random inspections and find that random inspections by the CSRC reduce firms' stock price crash risk.

Purpose This study examines the complementarity of two public enforcement mechanisms, the random audit inspection conducted by the CSRC and the initial public offering (IPO) review process for audit firms’ clients by the stock exchanges. Design/methodology/approach Our initial sample includes all firms listed on the STAR market from its establishment in July 2019 through December 2022. We manually collect random audit inspection data from the CSRC ROs' official website and the issuance of comment letters during the IPO process from SSE’s official website. We obtain other data (e.g. firms’ post-IPO performance data) from the China Stock Market and Accounting Research database (CSMAR). Findings Utilizing a hand-collected dataset of random audit inspection and IPO review data, we find that IPO review intensity significantly increases for clients of inspected audit firms, especially when the audit firms are found to have issues during the random audit inspection. This effect is stronger when the reputations of the audit firms or underwriters are lower and external oversight is strengthened. Furthermore, clients of inspected auditors face more inquiries requiring auditors' independent opinions, longer reply intervals and IPO delays. Following random audit inspection, there is a marked tendency among IPO firms to update their prospectuses. Due to the deterrence effect, we find that random inspections influence IPO approval rates and post-IPO performance when audit firms are penalized. Practical implications Firstly, despite the improvement of audit quality after the random inspection, our findings show the causal effect of random audit inspection on IPO review intensity, which can serve as evidence of regulatory complementarity. Secondly, our paper demonstrates that regulators are concerned about auditor regulation and the consequent higher public pressure in the IPO review process, which further highlights the gatekeeper role audit firms should play in information disclosure quality and the importance of public opinion in the IPO review process. Originality/value Firstly, our paper contributes to the extensive literature on the IPO review process by identifying the audit regulation as a significant regulatory antecedent. This study is one of the few that directly examines how regulatory activities within regulatory agencies affect exchange-led listing reviews. Secondly, we diverge from prior studies by introducing the random audit inspection to identify the causal effect and examining the real economic consequences of securities regulation.

Preventive regulation and corporate financialization: Evidence from China Securities Regulatory Commission's random inspections

The random inspection of the China Securities Regulatory Commission (CSRC) is an important policy for practicing “standardizing regulatory behavior and innovating management modes”. This study investigates how CSRC’s random affect capital market information efficiency from the perspective of stock price synchronicity. Using a sample of China’s non-financial A-share firms from 2013 to 2019, we find that random inspections significantly reduced the stock price synchronicity of inspected firms. Random inspections could increase the probability of releasing management earnings forecasts, media coverage and investor attention, and thereby improve information efficiency. Further study finds that the effect of random inspections on stock price synchronicity is stronger for non-state controlled firms, districts with more listed firms, and districts with more transparent government. This study enriches the literature on the consequences of random inspections and extends our knowledge of the relationship between regulatory innovations and the information efficiency of the capital market.

Has the QFII Scheme Strengthened Corporate Governance in China? Michael N.T. Tan (bio) Introduction Corporate governance in China has had a difficult journey since the economy opened up in the late 70s and made the gradual transition from a centrally planned economy to a market economy. In the 90s, with the establishment of the Shanghai and the Shenzhen stock exchanges and the promulgation of the Companies Law, corporate governance came into vogue. Then, following the Asian Financial Crisis in 1997/98, corporate governance assumed greater importance. The China Securities Regulatory Commission (CSRC) is the main regulatory body for listed entities and it was set up in 1992. Over the last 17 years, it has attempted to institute good corporate governance including transparency, information disclosure, protection of minority shareholders' interests and rules for the appointment of independent directors. In an attempt to improve corporate governance in China's listed companies, the CSRC established the Qualified Foreign Institutional Investor (QFII) scheme reasoning that the presence of foreign institutional investors on the register of shareholders would help improve corporate governance in the Chinese companies they invest in. This article seeks to answer whether the QFII scheme has in fact strengthened corporate governance in the Chinese listed entities. The Qualified Foreign Institutional Investor (QFII) Scheme The QFII scheme was conceived by the CSRC and modelled after the QFII scheme adopted by Taiwan in 1991.1 Improved corporate governance was a [End Page 353] major objective. According to Ferguson and McGuinness, "the QFII scheme carries tremendous potential as a vehicle for raising corporate governance standards".2 Steven Yeo states that "with the advent of foreign institutional investors in the PRC market, with their more robust due diligence and investment disciplines, it is anticipated that the QFII Provisional Measures will further encourage greater transparency and improve the compliance and corporate governance process of A share companies …."3 Fred Hu opines that "the participation of global investors in China's domestic securities market has introduced professional funds management expertise and provided a new advocate for improving corporate governance ….4 This view was further echoed by Richard Ward, Chairman of UBS Warburg who remarked on 26 November 2002 "that QFII will be an important stimulus for improving corporate governance in China because increasingly Mainland companies will be benchmarked against their international peers".5 It was the hope of the CSRC that the QFII scheme would contribute to better corporate governance. The Director General of the CSRC stated at a seminar in Hong Kong on 8 November 2002 that with the promulgation of the QFII scheme, "foreign institutional investors would be able to play a positive role in improving corporate governance in China". It was presumed by the CSRC that the QFII participants, all of whom would be from countries with well regulated financial systems, would require sound corporate governance in their target companies to justify their long term investment horizons. This article seeks to ascertain what areas of corporate governance were impacted after some five years of operations. Specifically, how did QFIIs impact shareholders, management, board of directors and market discipline? [End Page 354] The QFII Scheme — Rules and Regulations The legal basis for the QFII scheme is laid out in the "Provisional Measure on Domestic Securities Investments by Qualified Foreign Institutional Investors — Decree No. 12 of 5 November 2002. The objectives as stated in Article 1 are twofold:6 (i). To govern Qualified Foreign Institutional Investors' investments in China's securities market7 and (ii). To promote development of China's securities market8 What can QFII invest in? Article 18 of the Provisional Measure states that the QFII can invest in the following RMB financial instruments: (i). Shares listed in China's stock exchanges (excluding B shares) (ii). Treasuries listed in China's stock exchanges (iii). Convertible bonds and enterprise bonds listed in China's stock exchanges and (iv). Other financial instruments as approved by CSRC Conditions of the Scheme The rules are very clear. Only the very large foreign financial institutions need apply for fund managers, they must have assets in excess of US$10 billion during the most recent accounting year and have operated for over five years. Insurance companies must have assets...

The China Securities Regulatory Commission (CSRC) has randomly selected two audit firms each year to check their problems in management and internal control since 2016. Using the random inspections from 2016 to 2018, we construct a staggered DID model and find that the possibility of audit firms engaging in audit opinion shopping decreases after they are inspected. To explore the underlying logic, we document that: (1) the random inspections strengthened audit firms’ management of branch offices, resulting in a more pronounced effect on the practice of branch audit offices; and (2) the policy improved audit firms’ internal control, leading to more pronounced effect in audit firms with a heavy workload and loose control. Further, we show that punishments following the inspections strengthen the basic effect, while the effect of random inspections would be weakened for the big 10 audit firms.

Introduction Corporate governance in China has had a difficult journey since economy opened up in late 70s and made gradual transition from a centrally planned economy to a market economy. In 90s, establishment of Shanghai and Shenzhen stock exchanges and promulgation of Companies Law, corporate governance came into vogue. Then, following Asian Financial Crisis in 1997/98, corporate governance assumed greater importance. The China Securities Regulatory Commission (CSRC) is main regulatory body for listed entities and it was set up in 1992. Over last 17 years, it has attempted to institute good corporate governance including transparency, information disclosure, protection of minority shareholders' interests and rules for appointment of independent directors. In an attempt to improve corporate governance in China's listed companies, CSRC established Qualified Foreign Institutional Investor (QFII) scheme reasoning presence of institutional investors on register of shareholders would help improve corporate governance in Chinese companies they invest in. This article seeks to answer whether QFII scheme has in fact strengthened corporate governance in Chinese listed entities. The Qualified Foreign Institutional Investor (QFII) Scheme The QFII scheme was conceived by CSRC and modelled after QFII scheme adopted by Taiwan in 1991.1 Improved corporate governance was a major objective. According to Ferguson and McGuinness, the QFII scheme carries tremendous potential as a vehicle for raising corporate governance standards. (2) Steven Yeo states with advent of institutional investors in PRC market, their more robust due diligence and investment disciplines, it is anticipated QFII Measures will further encourage greater transparency and improve compliance and corporate governance process of A share companies.... (3) Fred Hu opines the participation of global investors in China's domestic securities market has introduced professional funds management expertise and provided a new advocate for improving corporate governance.... (4) This view was further echoed by Richard Ward, Chairman of UBS Warburg who remarked on 26 November 2002 that QFII will be an important stimulus for improving corporate governance in China because increasingly Mainland companies will be benchmarked against their international peers. (5) It was hope of CSRC QFII scheme would contribute to better corporate governance. The Director General of CSRC stated at a seminar in Hong Kong on 8 November 2002 promulgation of QFII scheme, foreign institutional investors would be able to play a positive role in improving corporate governance in China. It was presumed by CSRC QFII participants, all of whom would be from countries well regulated financial systems, would require sound corporate governance in their target companies to justify their long term investment horizons. This article seeks to ascertain what areas of corporate governance were impacted after some five years of operations. Specifically, how did QFIIs impact shareholders, management, board of directors and market discipline? The QFII Scheme--Rules and Regulations The legal basis for QFII scheme is laid out in Provisional Measure on Domestic Securities Investments by Qualified Foreign Institutional Investors--Decree No. 12 of 5 November 2002. The objectives as stated in Article 1 are twofold: (6) (i) To govern Qualified Foreign Institutional Investors' investments in China's securities market (7) and (ii) To promote development of China's securities market (8) What can QFII invest in? Article 18 of Measure states QFII can invest in following RMB financial instruments: (i) Shares listed in China's stock exchanges (excluding B shares) (ii) Treasuries listed in China's stock exchanges (iii) Convertible bonds and enterprise bonds listed in China's stock exchanges and (iv) Other financial instruments as approved by CSRC Conditions of Scheme The rules are very clear. …

Spot check on corporate disclosure quality: Insights from policy learning

Credit rating is a primary determinant of firm cost of debt capital, capital structure, and hence the range of acceptable investment opportunities. Scant research has been conducted thus far on the relation between internal controls and cost of capital, particularly after the 2002 Sarbanes–Oxley Act. However, academic researchers argue that credit ratings may be affected by internal governance mechanisms instituted by firms and that the quality of internal controls is a potential driver of cost of equity capital. This paper examines whether firm credit ratings is associated with the quality of internal control over financial reporting. Using a sample of firms disclosing internal control weaknesses during November 2003–July 2005, I find that firms with low internal control quality are more likely to have lower credit ratings, speculative-grade rating, smaller size, lower profitability, lower cash flows from operating activities, net losses in the current and prior fiscal year, higher income variability and higher leverage than firms compared to firms with high-quality controls. Further, lower quality controls decrease the likelihood of a firm receiving an investment-grade debt rating; hence, resulting in higher cost of debt financing, lower income and lower overall attractiveness in capital markets for these firms. Finally, results also suggest that corporate governance strength is positively related to internal control quality. Study results should be useful to a wide range of academic and business readers, because it suggests the increasing importance of firm internal controls in financing decisions and cost of capital determination, of investment in proper internal controls and of exploring the various possibilities from instituting high-quality internal controls. Additionally, regulators are advised to take into consideration the potential effect of legislation on firm credit ratings and internal control quality.

Whether internal controls can effectively constrain earnings management, which is a hot topic in recent years. I investigate the impact of internal control on earnings quality based on a life cycle perspective using data of listed companies of China’s market from 2010-2013. The empirical findings indicate that high quality internal control can suppress accrual earnings management and real earnings management (except for discretionary expenses manipulating earnings management) effectively, whilst in different life cycle stages (LCSs), the relation between internal control quality and accounting earnings quality (accrual quality and real earnings quality) is different. For the accrual quality aspect, in mature LCS, internal control quality and accrual quality is positively correlated. In growth or decline LCS, the relation between internal quality and accrual quality is not significant. For the real earnings quality aspect, in decline LCS, high quality internal control can improve real earnings quality; in growth LCS or mature LCS, the relation is just the opposite.

INTRODUCTION In a sense, I began developing this presentation in 1993 when I first taught auditing and internal control for M.B.A.s at INSEAD (European Institute of Administration). In designing the course, I envisioned myself as the CEO of a multinational corporation (as many M.B.A.s view themselves), and asked how would I know whether I was getting the right information for decision making, that my assets were being protected, and that my people were complying with laws, regulations, and company policy--all on a worldwide basis? As I pondered these questions, it came to me that an answer to all of them is internal control. This revelation changed my thinking about internal control, changed the tone of the M.B.A. course, and also changed my teaching for majors,(1) I now believe that knowledge about internal control is an essential element that affects the welfare of management, corporate directors, shareholders, trading partners of an entity, auditors, and society at large--yet it is relatively unexplored by researchers. All major research methods are applicable, we have conceptual documents to guide our inquiries, and internal control quality is regulated directly or indirectly in many countries. In short, there is an outstanding opportunity for research in internal control for and auditing professors, and for Ph.D. students. There are substantial barriers, of course, and we must all work to overcome them. The rest of this paper explores research opportunities in internal control quality assurance beginning with a definition of internal control and the demand for internal control quality and quality assurance. This is followed by a discussion of barriers to research, and concludes with research questions and trends for the future. DEMAND FOR INTERNAL CONTROL QUALITY AND QUALITY ASSURANCE Because I am most familiar with them and because other groups around the world have conceptually similar definitions, I will use the Committee of Sponsoring Organizations of the Treadway Commission definition of internal control (COSO 1992) supplemented by that of Criteria of Control (CoCo, CICA 1995).(2) COSO defines internal control as: a process, effected by an entity's board of directors, management and other personnel designed to provide reasonable assurance regarding the achievement of objectives in the following categories: * effectiveness and efficiency of operations * reliability of financial information * compliance with the applicable laws and regulations (COSO 1992) (emphasis added) The COSO definition implicitly assumes a constant external environment. The Canadians' CoCo adds the risk of failure to maintain the organization's capacity to identify and exploit opportunities, and resilience or capacity to respond or adapt to unexpected risks and opportunities. Thus, CoCo assumes the external environment may change, and defines good internal control to include adaptability of the process to a changing external environment. The COSO/CoCo definitions have three distinguishing features. First, they are broad, much broader than traditional definitions of internal accounting control that are limited to reliability of data and protection of tangible assets. By including the efficiency and effectiveness of operations, compliance with laws and regulations, and responsiveness to external changes, the COSO/CoCo definitions can be interpreted to cover all of management's functions except choosing objectives, strategies to achieve objectives, and follow up of surprises identified. Second, the COSO/ CoCo definitions are about process, rather than about a static state. This means that internal control cannot be directly observed or verified. Third, internal control is about risk, or threats that an entity will not achieve its objectives. All decision makers want to optimize their risk/expected reward trade-off, thus leading to demand for internal control quality and quality assurance. …

This paper introduces internal control quality to study litigation risk which enrich the literature of how to reduce firms’ litigation risk. This paper use listed company data from 2000-2015 in China A-share market to research how firms’ internal control affect litigation risk, and which kind of influence on litigation risk caused by internal control. By using regression model and conducting endogenous test, this paper finds that the higher internal control quality, the lower litigation risk of firms by reducing the number of involving litigation and funds used in lawsuit. If companies with good internal control quality, they can avoid many risks caught by litigation risk. Especially for firms in growth and undeveloped market, internal control quality can play a more vital role in corporate governance.

This paper establishes the evaluation index system of the quality of internal control of commercial banks. Then the paper combined with the improved adding calculated by entropy method within the accrual cash flow model of quality control index, the presence of internal control and the level of accounting conservatism were considered. This paper aims at figuring the relationship between the ability to internal control and accounting conservatism of listed commercial banks through the study, the representative of the financial field of the enterprises to strengthen internal control system to establish and improve the theoretical basis of information disclosure quality. Index Terms - The quality of internal control; Accounting Conservatism; Listed commercial banks. internal control quality, the assessment concluded the company self-assessment report, external auditors, sponsors and the board of directors or the supervisory board of the internal control evaluation could reflected the quality of internal control. Ref. (3) was proposed by Kong Fanfeng. He collected several listed Corporations' evaluation report of their internal control , and provide the audit report opinion type, in which the firm of listing Corporation in the stock exchange to be punished as a judgment of whether the company has major defects based on the internal control. Ref. (4) was proposed by Zhang Xiaolan, Shen Haojie, Yang mo. They) chose13 index form the self-evaluation and audit reports of the internal control in the listed Corporation based on COSO internal control framework concept. By using means of entropy model, he established the calculation method of internal control quality named ICDQ from two aspects of relevance and reliability. Not only does the internal control information index constructed by this method involves many aspects of the information objectively, but also can it reflect the quality differences between enterprises effectively. Overall, the research on quality of information disclosure of the internal control of the company went through three stages. First, the level of detail by enterprise internal control disclosure of information, this method was lack of objectivity, and using the amount of information as the criterion of effective information was not accurate. Second, utilize dummy variables like 0 or 1 to quantify the quality of internal control. If large amount of data processing, the tedious work of the case, this approach can reflect the advantage, but for some data internal audit report, this method would neglect the accuracy of information. Third, compared to the previous methods, the use of entropy model has two advantages, one is the internal control information can cover many enterprises finally, as a comprehensive index to reflect the results. Another is that when the information to consider become variable, model can also hold them. Therefore, this paper uses the entropy model to calculate the data quality of internal control of listed commercial banks About the study on measurement method of accounting conservatism, Ref. (5) was proposed by Basu. He proposed surplus stock returns the inverse regression measurement method (AT), using the timeliness of accounting conservatism and the properties of inverse coefficient in the regression model to reflect the economic losses in earnings. In order to figure the enterprise's accounting conservatism, Ball and Shivakumar thought AT method was born in the condition that America securities market so the effectiveness of the market

52 SFPM working group on DBT internal quality control

Digital transformation has become a new engine driving the development of enterprises. Based on the data of Chinese A-share listed manufacturing enterprises from 2008 to 2020, this paper measured the intensity of enterprise digital transformation with the help of machine learning method, and empirically investigated the impact mechanism of digital transformation on the quality of enterprise's internal control. It is found that digital transformation can significantly improve the quality of internal control. Mechanism analysis shows that digital transformation has a positive impact on the quality of internal control mainly by reducing agency costs and increasing the shareholding ratio of institutional investors. The results of heterogeneity analysis indicate that the promotion effect of digital transformation on the quality of internal control is more significant in enterprises with small scale and strong manager's ability. Digitization improves the total factor productivity of enterprises by promoting the quality of internal control.