Internal Control for Family-Owned Business

Internal Control in Family-owned Business

3/20/2016

Internal Control in Family-owned Businesses

Abstract:

      In human being’s history, the family is the most traditional and oldest unit. Nowadays, family-owned businesses are playing a very important role in many countries. Family-owned businesses are also the cornerstones of economical lives for those countries. Yet, the truth is family-owned firms are more possibly to have ineffective internal controls than non-family firms. There are two well-known proverbs in China talk about this phenomenon “The father buys, the son builds, the grandchild sells and his son begs” and “from clog to clog is only three generations”. The weak internal controls could result weaker misstatements and fraudulent accounting items in family-owned firms than in other types firms as well. Thus, increasing the quality of internal controls is an essential way to maintain family-owned businesses to survive and grow in competition. Through review of the literatures, this paper will explore the internal control for family-owned business and provide the possible appropriate strategies for increasing the level of internal controls in family-owned businesses. The two major findings in this study are: 1) understanding the reasons why there are more internal controls weaknesses in family firms than in non-family firms (how family ownership influences the effectiveness of internal controls); 2) provide appropriate suggestions for raising the level of internal controls in family-owned business.

Keywords: Family-owned business, Family ownership, Internal controls, Strategies.

1. Introduction

      Family-owned business is a crucial economical component in human being society. Throughout the history, family is the most important and easiest path for people to gain financial resources, social resources, and human resources. World widely, from ancient to modern times, and from agricultural and cottage industries to multinational corporations, family ownership is pervasive (Morck and Yeung, 2004). For example, there are several studies have shown that about 35 percent of Fortune 500 companies are family-controlled and 64 percent of U.S. gross domestic product was provided by family-owned businesses.

      Effective internal controls in family-owned businesses become more essential because family firms are playing the important role in economic development. The internal controls of family firms may be different from non-family firms because the owners of family firms, a class of shareholders unique to family firms, have both the ability and incentive to influence their firm’s internal control (Chen, Feng, and Li, 2007). In most family firms, family members usually serve as top executives such as managers, directors or shareholders. PCAOB document that the people who are in those positions play a significant role in firms’ internal controls (AS5, PCAOB 2007).