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Determinantsandconsequencesofinternalcontrolinfirms:acontingencytheorybasedanalysisAnnukkaJokipiiAbstract：Inordertoensuretheefficiencyandeffectivenessofactivities,reliabilityofinformationandcompliancewithapplicablelaws,firmsdemandadequateinternalcontrol.However,severalframeworksassumethattheneedforinternalcontrolvariesaccordingtoafirm’scharacteristics.Thisconcurswithcontingencytheory,whichclaimsthateachorganizationhastochoosethemostsuitablecontrolsystembytakingintoaccountcontingencycharacteristics.Thisstudyexamineswhichcontingencycharacteristicsfirmschoosetoadapttheirinternalcontrolstructureandwhetheritresultsinamorefavorableassessmentoftheeffectivenessofcontrolbythemanagement.Whilethecomponentsofinternalcontrolhavebeenexaminedindividuallyinthecontrolliterature.thispaperattemptstoshedlightoninternalcontrolandplaceitinabroadercontext.Theresults,derivedfromaweb-basedsurveyof741Finnishfirms,indicatethatfirmsadapttheirinternalcontrolstructuretodealwithenvironmentaluncertaintyandtoachieveobservedcontroleffectiveness.Alsothestrategyhasstatisticallysignificanteffectsoninternalcontrolstructure.Keywords:Internalcontrol;Effectiveness;Contingencytheory;Structuralequationmodeling1.IntroductionItisgenerallybelievedthataninternalcontrolsystemreducesrisksandhelpsfirmsensurethereliabilityoffinancialstatementsandcompliancewithlawsandregulations(SpiraandPage2003).So,anincreasingnumberofbusinessfailuresandsomewidelypublicizedfraudshaveencouragedfirmstoputmoreemphasisontheirinternalcontrolsystems,whicharespecifictotheirparticularoperatingenvironment.Managementisunderincreasedpressuretoenhancetheeffectivenessofinternalcontrolandtoeffectivelycommunicatethistotheboardofdirectorsandshareholders(Sutton2006).Referencegroupslikeauditors,suppliersandcustomersarealsointerestedininternalcontrolssincetheymayaffectlong-termconfidenceinreporting,accountabilityandinthecorporateformoforganization(RittenbergandSchwieger2001).Despitethefactthatinternalcontrolisanessentialfactoraffectingthefirm,theevidenceoftheactualperformanceofaninternalcontrolstructurewithintheorganizationalenvironmentisalmostnon-existent,andthetopicrelativelyunexploredbyresearchers,asnotedbyKinney(2000).Theprofessionalliteratureoninternalcontrolhasmadeprogresstowarddevelopinginternationalcontrolframeworks,butsofartheamountofinternalcontrolresearchislimited.SeltoandWidener(2004)analyzepublishedresearchandprofessionalarticlesandfindthattherewerefewerinternalcontroltopicsinthemanagementcontrolresearchliteraturethaninpracticalliterature.Increasingemphasisontheroleplayedbyinternalcontrolinbusiness(Maijoor2000),andthelackofexistingresearch,createsnewresearchneedsandopportunities.Thisstudycontributestotheunderstandingoftheinternalcontrolstructureanditsobservedeffectivenessincompanycontexts.Eventhoughtheinternalcontrolframeworks(COSO,COCOetc.)presentastandardizedstructureandobjectivesforinternalcontrol,theystilladvisethattheneedforeffectiveinternalcontrolvariesaccordingtoafirm’scharacteristics.However,neitherframeworksnorpriorliteratureprovideanadequatepictureoftherelationshipsbetweenafirm’scharacteristicsanditscontrolsystem.Therefore,thisstudyutilizesacontingencyapproachtoexaminethedesignoftheinternalcontrolstructureanditsobservedeffectivenessindifferentcontexts.Thestudyexaminesrelationshipsusingstructuralequationmodeling(SEM)andpresentsempiricalresultsfrom741firmsinFinland.Theresultsofthisstudyaddtothelimitedinternalcontrolresearchknowledgeinseveralimportantrespects.First,thestudypresentsempiricalfindingsusingmeasurementmodelsforinternalcontrolanditseffectivenessinpractice.Thereareorganizationsworldwidewhichhaveusedinternalcontrolframeworksasafoundationforconductingactivities.Atanyrate,thereislittleevidenceaboutframeworksoutsidepractice,andthusthemodelsdeservemoreintensiveresearchattention(COSO1994;SeltoandWidener2004).Withafewexceptions(e.g.,StringerandCarey2002)earlierstudieshaveusuallyconcentratedonparticularcontrolelements,suchasthecontrolenvironment(Aquila1998),communication(Hooksetal.1994)orriskassessment(Mills1997).Inthisstudytheinternalcontrolconceptisexaminedasawholeindifferentcontexts.Second,theactionofcontingencytheoryoninternalcontrolhasnotbeenexaminedsufficientlywithinthepriorliteratureeventhoughthatrelationshipplaysacriticalroleinbetterunderstandinginternalcontrolwithinorganizations.Third,thereisalackofknowledgeaboutinternalcontrolfromthepointofviewofmanagement.Theliteraturehassofarconcentratedontheexternalparties’view(Felix1998),althoughorganizinginternalcontrolintheorganizationisinfacttheresponsibilityofmanagement.Therefore,inthisstudytheperceptionsofthemanagementofthesurveyedfirmsarethefocus.Fourth,thisstudyexaminesimportantcontingencycharacteristicsthatshouldbetakenintoaccountwhenfocusingontheinternalcontrolinanorganization.Theaimistodeterminewhichcharacteristicsarehelpfulinexplainingvariationsinaninternalcontrolsystemanditsobservedeffectiveness.However,themodelexamined,yieldsdifferentresultswhenexaminedinabivariateorinamultivariatesetting.Therefore,thispaperdem