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1.
Introduction
In 2008, five regulatory authorities in China including the Ministry of Finance (MOF) (2008), the National Auditing Office, the China Banking Regulatory Commission, the China Insurance Regulatory Commission and the regulator of the Chinese stock market, the China Security Regulatory Commission (CSRC), jointly stipulated the Basic Standard of Enterprise Internal Control (Basic Standard hereafter). Subsequently, three supporting implementation guidelines were issued between 2008 and 2010. While the USA Sarbanes-Oxley Act (SOX) particularly focuses on the internal control directly related to financial reporting, China's Basic Standard extends its scope of internal control regulatory framework to much broader business management areas, with the internal control directly relating to financial reporting only constituting one section of the Basic Standard . The internal control regulatory framework in China identifies 18 internal control areas that business enterprises need to strengthen in order to maintain a sound internal control system.
Taking advantage of the newly established regulatory framework of the internal control system and the significant differences exhibited between the US SOX and Basic Standard in China, we aim to:
* investigate whether the disclosure of internal control weaknesses (ICWs) has a negative impact on accounting conservatism[1] in Chinese listed firms;
* investigate which type of ICWs, accounting-related versus non-accounting-related, has an impact on accounting conservatism, or in other words, whether a much broader internal control standard in China which extends from accounting-related to non-accounting-related internal control areas is necessary; and
* investigate whether additional assurance of internal control reports (ICRs) can mitigate the negative impact of ICWs on accounting conservatism.
The voluntary disclosure of ICW regimes in China provides listed Chinese firms with discretion on whether to release ICRs and disclose ICWs. It can be argued that firms providing ICRs voluntarily are more willing to fully report ICWs if any weaknesses exist. This is largely due to the consideration of litigation and regulatory risk. Listed Chinese firms are subject to legal obligation imposed by the Chinese Company Law and the Basic Standard that listed firms must provide true and fair information in their external reports, such as ICRs. Misleading information and non-disclosure of ICWs in ICRs will warrant CSRC sanctions. Therefore, it is unlikely that firms providing ICRs voluntarily chose to supply misleading ICW information because...