Increasing uncertainty and competition in the process of internationalization attaches much more difficulties and risks to small and medium enterprises (SMEs) for sustainable growth than large firms in emerging economies. Particularly in the current time of global economic downturn and burgeoning trade conflicts, SMEs face huge challenges and risks to compete for survival and sustainable growth due to a lack of internal and external resources in a turbulent market. While a considerable body of literature has discussed the factors that significantly contribute to firms’ sustainable growth, such as intellectual capital (Xu and Wang 2018
), international and financial capabilities (Ma et al. 2018
; Ye and Kulathunga 2019
), technology (Lyver and Lu 2018
), innovation and corporate social responsibility in developed and emerging markets (Ge et al. 2018
; Hong and Chao 2018
), there is little attention paid to the role of internal control as a tool of risk management in SME’s sustainable growth in emerging and transition economies.
As the Committee of Sponsoring Organization of the Treadway Commission (COSO 2017
) emphasizes, internal control not only is a framework of enterprise risk management, but also integrates with strategy and performance for sustainable growth. Recently, more studies are being called for by COSO
) to explore the role of internal control in promoting sustainable growth around the world, particularly in developing economies. To respond to the claims in academia and practice, the purpose of this study is to examine the role of internal control in the sustainable growth of SMEs in the large emerging economy of China.
Effective internal control may promote sustainable growth. First, internal control is used to reduce the likelihood of corporate misconduct and fraud. As well as being exerted from the top down, internal control can also be exercised bottom-up as an important internal governance mechanism providing internal checks and balances to constrain management’s ability to extract private benefits and expropriate shareholders (Jensen 1993
; Bushman and Smith 2001
; Acharya et al. 2011
). Due to lack of prevention and detection mechanisms, weak internal control provides convenient opportunities for managers to exploit private benefits, which may destroy sustainable growth.
Second, effective internal control is associated with lower capital cost. Effective internal control can reduce corporate risk and protect the interests of investors through a series of procedures and activities, and thus decrease a firm’s cost of capital (Beneish et al. 2008
; Dhaliwal et al. 2011
). Firms with low capital cost have a comparative advantage in resource allocation to create value and competitiveness, which in turn is helpful to promote sustainable growth of the firms.
Third, effective internal control leads to more efficiency of investment and operation. The optimal decision making in investment and operation is based on the information quality provided and assured by internal control. Effective internal control reduces wrong decisions and behaviors of a firm, and hence improves the efficiency of operation and investment by providing high-quality information (Cheng et al. 2013
; Cheng et al. 2018
). Internal control is not only linked to the efficiency of investment and operation in a firm, but also correlated with the resource allocation efficiency (D’Mello et al. 2017
), thereby jointly influencing the firm’s sustainable growth.
Accordingly, internal control is assumed to alleviate agency problems and thus exert a governance role by extant literatures, e.g., it is documented that internal control serves as a governance mechanism to constrain managers’ ability to extract private benefits from insider trading (Skaife et al. 2013
), safeguard corporate resources (Gao and Jia 2016
; Qi et al. 2017
), curb excessive compensation of executive (Paletta and Alimehmeti 2018
), and retain customer–supplier relationships (Bauer et al. 2018
). Therefore, internal control is also expected to perform a governance role in sustainable growth.
In addition, the role of internal control in firms’ sustainable growth is assumed to be moderated by multiple large shareholders. There are two competing explanations for the effects of multiple large shareholders. In one view, multiple large shareholders not only monitor managers but also each other. As a result, a firm with multiple large shareholders implements better corporate policies (Shleifer and Vishny 1986
; Pagano and Röell 1998
). In the other view, multiple large shareholders form controlling coalitions and collude to expropriate from minority shareholders (Bennedsen and Wolfenzon 2000
). Therefore, it is an empirical issue whether the role of internal control in firms’ sustainable growth may be reinforced or weakened by multiple large shareholders.
The above issues are tested by using a sample of SMEs listed in the largest emerging economy of China from 2011 to 2015. Internal control (IC) is measured as an indicator variable that is equal to one if the firm has effective internal controls in a particular fiscal year, and zero otherwise. The sustainable growth rate (SGR) is estimated by adopting the Higgins’ model (Higgins 1977
). The findings show that effective internal control significantly promotes SMEs to achieve sustainable growth, and the effect is moderated by multiple large shareholders, suggesting that the role of internal control is more prominent in SMEs with multiple large shareholders. These results are robust to a battery of sensitivity tests, including control for endogeneity using the Heckman two-stage procedure, and alternative proxies for sustainable growth and multiple large shareholders.
This study contributes to the literature in several ways. First, our study adds to the emerging literature on the determinants of sustainable growth by examining the governance role of internal control in sustainable growth. Previous studies focus on the role of intellectual capital, international and financial capabilities, technology, innovation, and social responsibility in a firm’s sustainable growth (e.g., Xu and Wang 2018
; Ma et al. 2018
; Ye and Kulathunga 2019
; Lyver and Lu 2018
; Hong and Chao 2018
). This study provides additional evidence on the understanding of internal control as a contributor of sustainable growth.
Second, this study extends the stream of research on the economic consequences of internal controls. Our findings corroborate the claims proposed by COSO
) and directly link effective internal control and sustainable growth as evidenced by using a large sample of listed firms in China. Extant studies primarily examine the governance role of internal control in accounting quality, operational efficiency, investment efficiency, asset safeguarding, agency problems, and capital costs (e.g., Doyle et al. 2007
; Beneish et al. 2008
; Dhaliwal et al. 2011
; Cheng et al. 2013
; Gao and Jia 2016
; Cheng et al. 2018
). Our study highlights the governance role of internal control in sustainable growth and provides additional evidence on its economic consequences.
Third, this study investigates the impact of multiple large shareholders on the association between internal control and sustainable growth. Our findings show that the governance role of internal control in firm’s sustainable growth is more prominent in SMEs with multiple large shareholders, indicating that multiple large shareholders moderates the governance role of internal control in sustainable growth.
The remainder of this paper proceeds as follows. Section 2
develops hypotheses. Section 3
describes the data and research methodology. Section 4
presents the empirical results. The conclusions are offered in Section 5
The purpose of internal control to promote sustainable growth of a firm is underlined in the report issued by COSO
). However, there is little empirical evidence on the governance role of internal control in sustainable growth of SMEs, especially with moderation effects of multiple large shareholders.
This study aims to examine the governance role of internal control in SMEs’ sustainable growth in the developing economy of China with the moderation effect of multiple large shareholders. Using a sample of SMEs listed in the China market from 2011 to 2015, we find that internal control significantly positively contributes to SMEs’ sustainable growth, supporting Hypothesis 1. This provides the empirical evidence for the claim of COSO
) that one of the goals of internal control aims to keep and improve sustainable growth.
Moreover, the governance role of internal control in SMEs’ sustainable growth is moderated by the balance of power among multiple large shareholders. Jiang et al.
) contend that multiple large shareholders have a governance role in corporate investment. We extend the line of the research and document that the governance role of internal control in sustainable growth is more pronounced for SMEs with multiple large shareholders, which particularly supports Hypothesis 2.
The above results are robust to a battery of sensitivity tests, including control for endogeneity using the Heckman two-stage procedure, and alternative proxies for sustainable growth and multiple large shareholders.
Our findings suggest that effective internal control not only helps firms improve investment and operation efficiency, as documented in prior studies, but also exercises a governance role in SMEs’ sustainable growth with moderation effects of multiple large shareholders. Our study extends the line of the research by providing evidence from the largest emerging economy of China and has implications for other emerging economies.