“Quantitative and qualitative investments in internal control personnel and firm operational efficiency: Evidence from Korea”

Although internal control systems in firms aim to provide reasonable assurance regarding objectives related to operations, reporting, and compliance, research focusing on operational efficiency is limited. This study investigates the impact of both quantitative and qualitative investments in internal control personnel on a firm’s operational efficiency. Utilizing a fixed-effect regression model, the Heckman (1979) two-stage model, and a two-stage least squares procedure, this study analyzes 4,471 firm-year observations from Korean listed firms from 2018 to 2020. The findings indicate a positive association be-tween investment in internal control personnel and operational efficiency. This relationship remains robust even under sensitivity tests and concerns of potential endogeneity, as confirmed by the Heckman and two-stage least squares models. Specifically, the Heckman model shows that the ratio of the number of employees (coef = 0.023, t-value = 5.20) and certified public accountants (coef = 0.256, t-value = 5.43) responsible for internal control is positively associated with operational efficiency. Average work experience (coef = 0.002, t-value = 1.84) of internal control personnel is also positively related to operational efficiency. This study provides empirical evidence for the significance of investing in internal control personnel to boost operational efficiency and suggests that firms should consider both quantitative and qualitative aspects of internal control.


INTRODUCTION
According to the Committee of Sponsoring Organizations of the Treadway Commission (COSO), an internal control system aims to facilitate efficient and effective company operations, covering both operational and financial performance.Specifically, the internal control framework has three categories of objectives: operations, reporting, and compliance.The COSO Internal Control-Integrated Framework (COSO, 2013) defined internal control as "a process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance." While existing research has extensively explored internal control's impact on reporting and compliance, studies addressing operational efficiency are scarce (Alexander et al., 2013).A few recent works (Feng et al., 2015;Cheng et al., 2018;Shin & Park, 2020) have begun to fill this gap, but the role of human resource investment in internal control personnel for operational efficiency remains underexplored, particularly in terms of quantitative and qualitative aspects.
In the academic literature, operational efficiency is the managerial effectiveness in converting resources into revenue.According to Demerjian et al. (2012), operationally efficient firms can either produce higher revenue for a given level of resources or, conversely, minimize the consumption of resources to produce the same level of revenue.Research indicates that high-quality internal information, stemming from robust internal control systems, is pivotal for optimal operational decisions (Bauer, 2016;Cheng et al., 2018;Choi et al., 2021).
The quality of a firm's internal control is contingent upon the human capital managing it.In the U.S., the Public Company Accounting Oversight Board (PCAOB) has highlighted that losing employees responsible for internal control can impair its effectiveness.Existing studies affirm the importance of both quantitative and qualitative investments in internal control personnel (Choi et al., 2013;Choi et al., 2021;Shin et al., 2017), suggesting that such human resource investments can enhance operational efficiency.

LITERATURE REVIEW AND HYPOTHESIS
In the United States, the Sarbanes-Oxley Act (SOX) of 2002 was enacted to enhance the quality and transparency of a firm's financial reporting (SEC 2002(SEC , 2003)).This legislation mandates that managers evaluate and report on the effectiveness of a firm's internal controls and requires auditors to verify these assessments.The aim is to ensure the delivery of reliable financial reports to external markets.Consequently, both regulators and investors expect that effective internal controls will improve not only the quality of a firm's financial reporting but also its overall information environment.In light of these objectives, a considerable amount of research has been conducted to study the impact of internal controls on financial reporting quality and the information environment.2015) investigate the effects of inventory-related material weaknesses on firm operations.They find that such weaknesses systematically reduce inventory turnover ratios and increase the likelihood of reporting inventory impairment.These findings suggest that ineffective internal controls can compromise a firm's operational efficiency.Specifically, the study argues that inaccurate inventory tracking and management result in abnormal order quantities and inventory levels, leading to increased holding costs.
In a similar vein, other recent research has provided evidence that a firm's internal controls play a significant role in determining its operational efficiency.For example, Cheng et al. (2018) document that firms with internal control material weaknesses have lower operational efficiency, as measured by frontier analysis, compared to firms without such weaknesses.They find that the negative effect of material weaknesses on operational efficiency is stronger for firms with a greater demand for high-quality information, more severe weaknesses, and, to some extent, smaller firms.
Their study also shows that remediation of material weaknesses leads to improvements in operational efficiency.Shin and Park (2020) discover that operational efficiency increases when internal control managers possess task-related and diverse firm knowledge, aligning with human capital theory.These findings suggest that the establishment and maintenance of effective internal controls are critical for enhancing a firm's operational efficiency, which can positively impact its overall performance and decision-making processes.
Generally, research investigating the effects of internal controls on a firm's operational efficiency has convincingly demonstrated that ineffective internal controls are more likely to produce errors in internal management reports, adversely affecting the firm's operational decisions.Anecdotal evidence further supports the argument that ineffective internal controls have a negative impact on corporate decisions.For example, in its 2019 annual report, Marriott International disclosed a material weakness in internal controls related to accounting for their loyalty program, which led to revenue recognition errors for 2018.Similarly, Peloton Interactive noted in their annual report dated June 30, 2021, that they had identified a material weakness in internal controls related to inventory management.Peloton Interactive specified that their internal controls were not effectively designed or implemented to ensure accurate physical inventory counts were captured and properly reported in financial statements.This anecdotal evidence explicitly indicates that ineffective internal controls can decrease a firm's operational efficiency by providing managers with inaccurate internal information.In summary, both academic and anecdotal evidence show that effective internal controls are crucial for enabling a firm to make optimal operational decisions, leading to higher operational efficiency.The significant effect of human resources on internal controls is also evident in practice.For example, Marriott International's 2019 annual report stated that an insufficient number of resources, including IT and accounting processes and personnel, led to material weaknesses in internal controls.
Similarly, MU Global Holdings disclosed that a lack of personnel resources related to internal controls, segregation of duties, and effective risk assessment results in material weaknesses.
In summary, existing research and practical examples suggest that investing in human resource for internal controls enhances a firm's financial reporting quality and internal information environment by bolstering the effectiveness of the firm's internal controls.Moreover, past studies propose that a firm's operational decisions largely depend on internally generated information.As such, an investment in human resource for internal controls is likely to improve a firm's operational efficiency.Considering the importance of investment in internal control personnel, this study aims to provide a more comprehensive understanding of the influence of human resource investment in internal controls by investigating the association between investment in internal control personnel and operational efficiency.Drawing upon previous literature reviews and anecdotal evidence, this study posits a positive effect of investment in internal control personnel on a firm's operational efficiency, leading to the following primary hypothesis: H: Human resource investment in internal controls is positively related to a firm's operational efficiency.

METHODS
This paper defines 'operational efficiency' as a firm's relative ability to transform corporate resources into revenue (Demerjian et al., 2012).Specifically, this study measures a firm's operational efficiency by using data envelopment analysis (DEA), a common method for evaluating the relative efficiency of decision-making units (DMUs), which presents each firm in this study.DEA efficiency θ is defined as the ratio of output to input: where s and m represent output and input, indexed by i and j, respectively.Meanwhile, n represents DMUs.(See Demerjian et al. (2012) for the detailed estimation process.) This study employs variables for human resource investment in internal controls internal controls drawn from information in the "Report on the Operation of the internal control System", a section within the firm's annual report.The variable EMPLOYEE t signifies the quantitative investment in internal control-related personnel, calculated as the number of internal control-related personnel divided by the firm's total employee count.Meanwhile, CPA t represents the qualitative investment in internal control-related personnel, measured as the number of internal control-related personnel who are certified public accountants (CPA), divided by the firm's total employee count.This provides a gauge of the expertise level of internal control-related personnel.Finally, the variable CAREER t represents the average working experience of employees responsible for internal control, offering another metric for qualitative investment in internal control-related personnel.
The primary objective of this study is to examine whether the investment in internal control-related personnel enhances a firm's operational efficiency.This study employs distinctive, manually collected data on internal control related personnel from Korean listed firms spanning the period from 2018 to 2020.As mentioned earlier, information on internal control-related personnel has been publicly available since 2002.However, the study focuses on data from 2018 to 2020 to account for potential effects from changes in the Act on External Audit of Stock Companies in 2017.Data related to internal control personnel is sourced from DART, Korea's equivalent of EDGAR in the U.S. Financial data and the total employee count for each firm are collected from the TS2000, KIS-Value database, and FnGuide database, which parallels Compustat in the U.S. The study intentionally excludes financial firms due to their unique industry characteristics.Finally, firms lacking the required data for each variable are also excluded, yielding a final sample size of 4,471, as outlined in Panel A of Table 1.

RESULTS
Table 2 provides the descriptive statistics of the variables.This study winsorizes at the top and bottom 1% for each continuous variable.The mean and median values of Efficiency are 0.895 and 0.897, respectively, as Efficiency is standardized by scaling with industry-year median value.The sta-tistics on the independent variables show that the mean value of EMPLOYEE is 0.090, indicating that approximately 9% of all employees are responsible for internal control.The mean value of 0.004 for CPA reveals that 0.4% of employees who are in charge of internal control are CPAs.CAREER shows a mean value of 4.705, which shows that the average working experience of internal control-related personnel is 110.5 months.who are CPA.Despite this, it is challenging to draw definitive conclusions about the relationship between human resource investment in internal controls and a firm's operational efficiency solely based on these correlation coefficients presented in Table 3.Hence, Table 3 reports the regression results, taking into account all variables used in the analytical model.Additionally, the variance inflation factor analysis linked with the regression study indicates that multicollinearity does not pose a concern in this investigation.
Table 4 shows the primary regression results for testing the hypothesis.The first column presents the outcome of the regression of a firm's operational efficiency on the ratio of the number of employees responsible for internal control to the firm's total workforce (EMPLOYEE).The coefficient of EMPLOYEE is positive (0.011) and significant (t-value = 2.53).The second column of Table 4 demonstrates that the number of internal con-trol-related certified public accountants (CPA) is positively related to a firm's operational efficiency, exhibiting a significant positive coefficient at the 1% level (0.194, t-value = 4.00).The result suggests that an increase in the number of employees responsible for internal control and internal control-related personnel who are certified public accountants enhances a firm's operational efficiency.It also implies that both quantitative and qualitative investment in internal control-related human resources is significantly related to a firm's operational efficiency.The third column explores the relationship between a firm's operational efficiency and the average work experience (in months) of internal control-related personnel (CAREER).The coefficient of CAREER is not statistically significant.To address the endogeneity issue associated with sample selection bias and improve the robustness of the analysis, this study also carries out a two-stage analysis based on Heckman's (1979) model.Table 5 shows results of Heckman's (1979) two-stage analysis.The results in Table 4, as previously mentioned, reveal that only EMPLOYEE and CPA are significantly associated with a firm's operational efficiency.However, as shown in Table 5, the coefficient of EMPLOYEE (0.023, t-value = 5.20) and the coefficient of CPA (0.256, t-value = 5.43) are still significantly positive, and the coefficient of CAREER (0.002, t-value = 1.84) becomes weakly positive when addressing endogeneity problems through Heckman's (1979) two-stage analysis.Control variables show qualitatively consistent results with the main analysis in Table 4, and additionally, inverse Mills ratio (IMR) reveals a significantly positive coefficient.Therefore, the results for the Heckman (1979) two-stage model more strongly support this study's main hypothesis by showing that both quantitative and qualitative investment in internal control-related personnel positively affects a firm's operational efficiency.Furthermore, the R 2 of the model increases when the study adopts Heckman's (1979) two-stage analysis, improving the explanatory power of the test.Although the study addresses potential endogeneity issues by adopting Heckman's (1979) two-stage model, one might argue possible omitted variables and reverse causality problems.Thus, two-stage least squares (2SLS) procedure is performed to address the endogeneity issue.Table 6 shows the results of the second stage of 2SLS.As shown in Table 6, results using the fitted value of EMPLOYEE, CPA, and CAREER are qualitatively similar to the main analysis.This result supports the main argument and indicates that the endogeneity problem is not a major concern when evaluating the validity of main results.

DISCUSSION
The results indicate that an increase in both the number of employees responsible for internal control and internal control-related personnel who are CPAs can enhance a firm's operational efficiency.These findings imply that both quantitative and qualitative investments in internal control-related human resources have a significant connection to a firm's operational efficiency, supporting the primary hypothesis of the study.However, one could raise potential endogeneity issues relating to self-selection bias.As shown in Table

CONCLUSION
The primary objective of this study is to investigate the influence of investment in personnel responsible for internal control on a firm's operational efficiency.This study offers compelling evidence that both quantitative and qualitative investments in internal control-related personnel yield positive outcomes for operational efficiency.To elaborate, the study identifies three key dimensions that are positively associated with enhanced operational efficiency: 1) the number of personnel dedicated to internal control, 2) the subset of internal control-related personnel who hold CPA license, and 3) the average work experience of internal control-related personnel.Importantly, the robustness of these findings is confirmed through advanced statistical methods.Specifically, both Heckman's (1979) two-stage analysis and the two-stage least squares (2SLS) procedures substantiate the core argument, even when accounting for potential endogeneity issues.
This study provides the inaugural evidence that investment in human resources related to internal control significantly associated with a firm's operational efficiency.Furthermore, the findings offer invaluable insights for various stakeholders -ranging from management and investors to regulatory bodies -underscoring the direct link between internal control-related human resource management and operational efficiency of the firm, a relationship vital for future performance.Recognizing the positive impact of human resource investment in internal control on operational efficiency is of paramount importance, especially considering that not all companies allocate resources to internal control-related human capital, even as the significance of internal controls in effective business operation continues to escalate.
This study conclusively illustrates that investing in internal control-related personnel significantly elevates a firm's operational efficiency.For managers, these findings could serve as a compelling guidepost: Committing resources to internal control-related personnel can be a strategic lever for attaining enhanced operational efficiency.Looking ahead, future research could delve into more nuanced areas, such as investigating the influence of specific activities or roles of internal control-related personnel across various departments on a firm's financial performance and market returns.
EMPLOYEE t , CPA t , and CAREER t , present quantitative and qualitative human resource investment in internal controls, respectively.KSE) to control for the characteristics of the stock market.The details of each variable can be found in Appendix A. Finally, this study controlled for both industry-and year-fixed effects.
To test the main hypothesis, referencing the research of Cheng et al. (2018) and Cho et al. (2015), this study used the following model:

Table 3 displays
Pearson correlations, demonstrating a significant negative correlation between the dependent variable, Efficiency, and the independ- ent variables, EMPLOYEE and CAREER.However, the result shows there is not a significant correlation between Efficiency and CPA, which represents the number of internal control-related personnel

Table 1 .
Sample selection

Table 4 .
Effect of investments in internal controlrelated personnel on a firm's operational efficiency

Table 6 .
Effect of investments in internal controlrelated personnel on a firm's operational efficiency: Two-Stage least squares (2SLS) regressions Antoncic and Antoncic (2011)2007)andAntoncic and Antoncic (2011)show that employee tenure and loyalty are significantly associated with firm growth.Thus, average wage of employees and asset growth rate are used as instrument variables for CAREER.The untabulated Sargan test for the validity of the instrument variables also provides evidence that the test fails to reject the null hypothesis that instrument variables are not correlated with the error term of the main regression, suggesting that the instrument variables are valid.

Table A1 .
Investment Management and Financial Innovations, Volume 20, Issue 3, 2023 Variable definition Efficiency Continuous variable of firm efficiency, ranging from 0 to 1, for fiscal year t based on the DEA (Demerjian, Lev, and McVay 2012).Ratio of number of employees responsible for internal control to total number of employees in firm CPA Ratio of number of CPAs responsible for internal control to total number of employees in firm CAREER The natural logarithm of average work experience of internal control personnel SIZE Natural logarithm of total assets Leverage Total liability divided by total asset AGE Natural logarithm of firm age (Natural logarithm of number of years a firm has appeared in database at end of fiscal year t) FCF Indicator variable that equals 1 if firm's free cash flow is not negative and zero otherwise FOREIGNC Indicator variable that equals 1 if firm reports a nonzero value for foreign currency adjustment in fiscal year t and zero otherwise MS Percentage of revenue (SALE) earned by firm within its industry for fiscal year t LARGE Share of ownership held by largest shareholder OUT Ratio of number of outside board members to number of board members ROA Net income divided by total asset at the beginning of the year KSE Indicator variable that equals 1 if a firm trades its shares on the KSE, and 0 if it trades on the KOSDAQ IMR Inverse Mills ratio obtained from first-stage Probit model http://dx.doi.org/10.21511/imfi.20(3).2023.23 APPENDIX A EMPLOYEE