INTERNAL CONTROLS AND FINANCIAL PERFORMANCE IN SMALL AND MEDIUM ENTERPRISES: FIRST EVIDENCE OF CORRELATION IN THE NORTHEASTERN ITALY CONTEXT

An effective internal control system (ICS) is expected to ensure that companies reach their goals, improve corporate governance, protect their assets, guarantee the reliability of financial information and prevent fraud. These important goals, activities and processes could affect a company’s financial performance. The agency theory and institutional theory both stress the importance of an effective ICS. Using a quantitative approach, this study investigated the relationship between the five components of an ICS as described in the Committee of Sponsoring Organizations framework and financial performance of small to medium enterprises (SMEs) in Veneto, Italy. The study used an industry and time-period fixed-effect ordinary least square regression model for testing hypotheses. Financial performance was assessed using two different financial ratios (ROA and ROA*). The analyses revealed that risk assessment as well as information and communication were significantly correlated with financial performance, while control environment, control activities and monitoring activities had less or no influence. This study offers empirical evidence of the importance of a good ICS in SMEs, at least in relation to some components, and their positive effect on a company’s financial performance.