Can independent directors improve internal control quality in China?

Abstract

This study conceptualises the monitoring power of independent directors (IDs) as consisting of specialist expertise or competence, incentives, balancing power and diligence. It then empirically investigates the influence of IDs’ monitoring power on internal control quality (ICQ), which is proxied by the voluntary disclosure of auditors’ reports on internal control and financial restatements released by China's A-share firms during 2006–2010. We find that the combined ID monitoring power index has a positive and significant effect on ICQ, which is robust to different proxies for ICQ, and that its components are also positively and significantly associated with either or (in most cases) both measures of ICQ. Overall, our evidence indicates that IDs’ monitoring power plays a positive role in improving ICQ in China.

Keywords:

• corporate governance
• independent directors
• internal control quality
• auditors’ reports on internal control
• financial restatement

JEL Classification:

• G18
• G34
• M41
• M48

Acknowledgements

The authors gratefully acknowledge financial support from Humanities and Social Science Research Projects of Ministry of Education of China (Grant Number: 12YJA790193, 11YJC630270) and the National Natural Science Foundation of China (Grant Number: 71272189, 70940025). The authors also appreciate two reviewers’ helpful suggestions.