Does Regulatory Reform of Internal Controls in China Improve Internal Control Effectiveness? Role of Corporate Social Responsibility Engagement

Abstract

The regulatory reform of internal controls (ICs) in China mandates that certain firms incorporate corporate social responsibility (CSR) engagement into ICs and issue IC reports. Using a staggered difference-in-differences research design, we find that IC effectiveness has worsened following this reform, but this deterioration is partially mitigated when mandated firms report their CSR engagement. Additional analyses demonstrate that this deterioration is further lessened when CSR reports are prepared in accordance with Global Reporting Initiative reporting guidelines or assured by external auditors and when firms spend more on CSR activities. Finally, cross-sectional analyses suggest that CSR engagement mitigates the deterioration in IC effectiveness more in non–state-owned enterprises and in firms that have better financial performance, lack political connections, or are located in regions with higher market development or social trust. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M4; M48.