Internal Control, Political Connection, and Executive Corruption

ABSTRACT

This paper examines the effect of internal control with a focus on implicit corruption of executives. Using the data from Chinese listed companies since 2010, we find that internal control plays a significant role for preventing corruption, but it is weakened if executive has political connections. These political connections tend to be representative-type rather than official-type. Our findings also suggest that compared with state-owned enterprises, internal control mechanisms in non-state-owned ones are more likely to be weakened when executives with political connection. Furthermore, we provide evidence that as executives’ political connections getting tighter, internal control which can prevent corruption becomes less effective.

KEYWORDS:

• Internal control
• executive corruption
• political connection

JEL:

• M10
• M14
• M42

Acknowledgments

We thank the anonymous reviewers for their helpful comments and suggestions.

Notes

1. Yao (2002) classifies executive corruption into two types: implicit and explicit. Explicit corruption of executives refers to the obvious violation of laws and regulations carried out by executives in order to seek private interests. Implicit corruption of executives refers to the rent-seeking behavior in which executives use excess perquisites to obtain excessive compensation and finally seize private interests through such hidden ways.

2. In fact, since Jan. 1st, 2012, the listed companies on the main boards of Shanghai Stock Exchange and Shenzhen Stock Exchange began to implement the basic norms for enterprise internal control and the supporting guidelines for enterprise internal control.

3. A Chinese expression, meaning relation and connection.

4. This item may include the following expenses related to executive perquisites: (1) office administrative expenses; (2) business travel expenses; (3) business entertainment expenses; (4) communication expenses; (5) training abroad expenses; (6) board meeting expenses; (7) company car and chauffer service; (8) conference expenses. Executives may reimburse expenses and transfer personal perquisites to company expenses.

5. Here we only report all the descriptive statistical results of the first calculation (Equation 1(1) $\frac{Perk{s}_{it}}{Asse{t}_{it-1}}={\beta }_0+{\beta }_1\frac{1}{Asse{t}_{it-1}}+{\beta }_2\frac{\mathrm{\Delta }sal{e}_{it}}{Asse{t}_{it-1}}+{\beta }_3\frac{PP{E}_{it}}{Asse{t}_{it-1}}+{\beta }_4\frac{Inventor{y}_{it}}{Asse{t}_{it-1}}+{\beta }_{5}Lnemploye{e}_{it}+{\epsilon }_{it}$(1) ) due to texts limitations.

6. According to the “Notice on Implementing Internal Control Standards for Enterprises Listed on the Main Board in 2012” issued by China’s Ministry of Finance and the China Securities Regulatory Commission (CSRC), the time for the listed company to implement the internal control standard system is determined according to four indicators: the fiscal year, the nature of the property rights, the company’s total market value under the CSRC’s algorithm on Dec. 31st, 2011, and the average net profit for 2009–2011. This regulation forced the listed companies to implement the internal control standard system with policy forces, which had a significant impact on the standardization and improvement of the internal control system of Chinese listed companies in the future.

7. When calculating the perks, we just use the result of administrative expense deducting the remuneration of directors, senior management, and members of the board of supervisors, the amortization of intangible assets in the current year, long-term deferred expenses, and other items that obviously do not belong to perks.

Additional information

Funding

This work was support by Jiangsu Provincial Department of Finance (Social Science Fund) under Grant no. [20WTB005]; and the University-Industry Collaborative Education Program by the Ministry of Education of China under Grant no. [201702022005, 201802100011 and 202002314026].