Is internal control more efficient in employee-friendly firms?

This paper investigates whether the internal control quality of employee-friendly firms is higher. The existing literature in the field of corporate governance mainly focuses on the impact of management incentive and pays less attention to ordinary employees. Using data from China over the time period from 2007 to 2019, we identify employee excess compensation to measure employee-friendly firms and examine its impact on the quality of internal control. We provide new evidence that employee-friendly firms can significantly improve internal control quality. We also find that it is easier to achieve the goals of internal control in employee-friendly firms. We further find that employee-friendly firms can enhance internal control quality by increasing employee quality. In addition, we document novel results that employee-friendly firms reduce corporate risk and enhance innovation by improving internal control quality. Collectively, the study reveals the effect of employee-friendly firms on the quality of internal control, not only enriches the literature on employee motivation based on efficiency wage theory and enriches the literature on the determinants of internal control quality from the perspective of employees, but also provides important implications for internal control practices.