In many countries, especially developing countries, governments play a vital role in corporate decision-making (Boubakri et al., 2012). Within China’s unique economic system, the government often intervenes in firms’ operational decisions by strengthening the involvement of Communist Party organizations in corporate governance. There are two strands of literature closely related to our research.

One stream of literature explores the effect of party organization governance. Extensive research demonstrates that party organizations’ participation in corporate governance contributes to improving investment efficiency (Li et al., 2020), curbing executive corruption (Yuan et al., 2023), and weakening managerial power (Wang et al., 2023), thereby significantly promoting corporate performance (Xie et al., 2022) and enhancing corporate innovation (Lin et al., 2023). Few studies examine the impact of party organization embedded on internal control quality. For instance, Yan et al. (2024b) adopt the proportion of party members on the board of directors, senior executives, and supervisory board to measure party organization governance, finding that party organization governance promotes internal control quality.

Another stream of literature examines the determinants and economic effects of internal control quality. Many scholars point out that executive compensation (Balsam et al., 2014; Han et al., 2022), executive characteristics (Lin et al., 2014; Shen et al., 2021), executive backgrounds (Ge and Xiong, 2023), board structure (Chen et al., 2017; Hu et al., 2017), shareholding structure (Li et al., 2021), social trust (Liu et al., 2022), and institutional environments (Chen et al., 2022) are important factors affecting internal control quality. Other scholars investigate the impact of internal control on the credit spread on publicly traded debt (Dhaliwal et al., 2011), changes in suppliers’ or customers’ relationship-specific investments (Lai, 2019), corporate research and development (R&D) investment (Li et al., 2019), and corporate environmental, social, and governance (ESG) information disclosure (Yan et al., 2024a).

Existing literature has conducted extensive research on the impact of party organization governance and on the determinants and economic consequences of internal control quality. However, there is little literature that directly examines the relationship between party organization governance and internal control. Yan et al. (2024b) examine the impact of party organization embedded on internal control, but their focus is neither on party organization governance formed by the CPOPD decision-making mechanism nor on revealing the underlying mechanisms through which party organization governance affects internal control quality. We first consider the CPOPD decision-making mechanism as an exogenous shock and examine the impact of party organization governance on internal control quality, thereby improving and expanding the relevant literature. Second, we combine institutional theory and agency theory to reveal the underlying mechanisms through which party organization governance affects internal control quality, thereby providing a theoretical foundation for future research. Third, we further explore the heterogeneous role of party organization governance at different levels of internal and external governance, providing empirical references for improving party organization governance.

The main theoretical support for party organization governance effects comes from institutional theory and agency theory. Institutional theory focuses on the interaction between institutions and organizations and emphasizes the constraining and regulating roles of formal institutions on firm behavior (Zhou et al., 2017). The CPOPD decision-making mechanism, as a formal institutional arrangement for the party organization’s participation in the corporate governance of SOEs, empowers party organizations to participate in major decisions and emphasizes the legitimate status of the party organization as an internal supervisor. Party organization governance formed by the CPOPD decision-making mechanism is conducive to improving major decision-making procedures, strengthening the internal supervision mechanism, and thereby improving the internal control quality of SOEs. Agency theory indicates that the separation of ownership and management leads to serious agency problems (Jensen and Meckling, 1976), which affect firms’ internal control. For example, Zhang et al. (2020) and Han et al. (2022) indicate that SOEs with dual principal-agent problems may have internal control deficiencies. Accordingly, the CPOPD decision-making mechanism establishes the legal status of party organizations as internal governance subjects, providing a normative foundation for their participation in SOE governance. As an important supplement to traditional governance forces, party organizations can effectively mitigate agency conflicts in SOEs by participating in the decision-making process for “Three Major and One Large” matters, thereby enhancing internal control quality.

More specifically, party organization governance formed by the CPOPD decision-making mechanism can improve internal control quality in three aspects. First, the CPOPD decision-making mechanism clearly stipulates that major matters must be discussed in advance by party organizations before being decided by management. Party organizations evaluate compliance risks and potential consequences during the discussion, thereby reducing corporate violations at the source and improving the quality of internal control. For instance, in 2017, the Jinan Culture and Tourism Development Group in Shandong Province suffered from excessive venture capital and severe loss of state-owned assets due to non-standard deliberation system and procedures of the party organization. After 2023, the group strictly implemented the CPOPD decision-making mechanism, effectively reduced illegal decision-making, and significantly increased corporate profits. Second, party organizations can gain greater access to internal business information through direct participation in major business decisions, significantly reducing information asymmetry between supervisors and operators. Therefore, party organization governance can curb earnings manipulation of executives who take advantage of inside information for personal interests, subsequently strengthening internal control quality. Third, the participation of the party organization in the decision-making of the “Three Major and One Large” matters can not only reduce management’s discretionary power over the firm’s resources but also strengthen the supervision of executives’ behavior, effectively curbing on-the-job consumption of management (Guo et al., 2019). Xie et al. (2022) believe that political governance formed by integrating party leadership into the corporate governance structure may significantly curb executive corruption.

Based on the above analysis, the CPOPD decision-making mechanism legitimizes the embedding of party organizations and establishes formalized decision-making procedures through explicit institutional arrangements, providing an institutional foundation for party organization governance. As internal supervisors, party organizations can effectively reduce corporate violations, inhibit earnings manipulation, and curb on-the-job consumption through pre-discussion of major matters, thereby improving internal control quality. Therefore, we propose the following hypothesis:

H1. Party organization governance can improve internal control quality.

Incentive compatibility refers to aligning the interests of executives with those of the firm, enabling executives to work hard for their own benefit while maximizing the interests of the firm. Executive equity incentives can bind executive interests to firm value. Internal control quality is closely related to firm value (Beneish et al., 2008). Kim et al. (2011) identify that internal control deficiencies lead to higher capital costs and more negative credit ratings, thereby decreasing firm value. Since internal control deficiencies negatively impact executive wealth, executives have a stronger motivation to improve internal control in firms with more executive shareholding. In particular, executives may work harder to increase their wealth by increasing firm value. Moreover, executives may reduce violations, earnings manipulation, and corrupt behavior to avoid stock price declines triggered by the disclosure of internal control deficiencies. However, executives cannot derive excess returns from favorable firm performance without adequate equity incentives. As a result, executives may construct poor internal control and attempt to extract firm value for personal gain. According to the above analysis, we expect party organization governance formed by the CPOPD decision-making mechanism to play a limited role in firms with more executive shareholding. However, party organization governance in firms with lower executive shareholding tends to be more strongly associated with greater internal control quality. This argument leads to the following hypothesis:

H2. Compared with firms with more executive shareholding, the positive effect of party organization governance on internal control quality is more significant in firms with lower executive shareholding.

Corporate governance theory emphasizes that the improvement of corporate governance efficiency depends on the collaborative effect of internal and external governance mechanisms. Analysts, an important external supervisory force, play an external governance role by directly monitoring or attracting investors to scrutinize the behavior of corporate managers (Xie et al., 2024). On the one hand, analysts directly supervise executives by collecting private information, screening executives and the governance system of the companies they cover, and rating corporate governance (Lehmann, 2019). In this situation, executives realize that any violations may be disclosed by analysts, prompting them to proactively reduce violations and construct sound internal control to achieve a higher corporate governance rating (Huang et al., 2020). On the other hand, analysts transmit abundant corporate information to external stakeholders through ratings and reports, which can not only strengthen the supervision and restraint by external investors over executives, but also mitigate information asymmetry, thus reducing the risk of executives taking advantage of their informational advantage to engage in earnings manipulation and on-the-job consumption (Liu et al., 2021; Xie et al., 2024). In contrast, outside investors can rarely acquire critical internal information from professional analyst reports in firms with lower analyst attention. Low information transparency makes it difficult for outside shareholders to monitor and discipline executive behavior effectively. In this case, executives are inclined to build weak internal control systems to gain more private benefits. Consequently, we argue that party organization governance formed by the CPOPD decision-making mechanism may play a more significant role in improving internal control quality for firms with lower analyst attention than those with more analyst attention, as it can compensate for the shortcomings of the external market governance mechanism. This gives rise to the following research hypothesis:

H3. Compared with firms with more analyst attention, the positive effect of party organization governance on internal control quality is more significant in firms with lower analyst attention.

We adopt a firm-level sample from Chinese A-share listed firms in Shanghai and Shenzhen from 2012 to 2022. According to the regulations of the Chinese Ministry of Finance, all main board-listed companies were required to construct an internal control system starting in 2012. Thus, we select 2012 as the starting point to increase the reliability of our findings. We use the following criteria for sample selection. First, we eliminate financial firms as defined in the China Securities Regulatory Commission’s 2012 classification, insolvent firms, and special treatment (ST) and *ST firms. Second, to enhance the accuracy of the empirical study, we supplement the data on firms missing ownership-type information by searching annual reports. Third, we exclude firms listed after 2012. Fourth, we remove samples with missing values for the dependent, independent, and control variables. The final sample contains 2113 firms with 20,564 firm-year observations. We obtain internal control index score from the DIB Internal Control and Risk Management Database, which is widely used and cited by Chinese scholars, firms, and media. The data on the implementation of the CPOPD decision-making mechanism in SOEs is derived from the company’s charter. In addition, the relevant financial data is obtained from the China Stock Market and Accounting Research (CSMAR) database and listed firms’ annual reports.

Following Hu et al. (2023), we construct the following empirical model to investigate the effect of party organization governance formed by the CPOPD decision-making mechanism on internal control quality using a difference-in-differences approach.

(1)$$I{C}_{it}={\beta }_0+{\beta }_1{\text{ Party }}_{it}+{\beta }_2{\text{ Controls }}_{it}+{\mu }_i+{\eta }_t+{\epsilon }_{it}$$

where, the subscripts i and t denotes the firm and year, respectively. IC_it represents internal control quality. Party_it denotes party organization governance. Controls_it denote a series of control variables, ${\mu }_i$ and ${\eta }_t$ denote firm- and year-fixed effects respectively. The estimated coefficient ${\beta }_1$ indicates the effect of party organization governance on corporate internal control quality.

Table 3 presents the estimates of internal control quality. Column (1) contains only Party, firm- and year-fixed effects. In column (2), all control variables are added to the specifications in column (1). The estimated coefficients of Party in columns (1) and (2) are all significantly positive at the 1% level, suggesting that our estimates are robust. The estimated coefficient of Party in column (2) is 0.0141, indicating that party organization governance formed by the CPOPD decision-making mechanism induces a 0.0141 increase in the IC coefficient, implying that party organization governance corresponds to a 14.10 increase in the corporate internal control index score, representing a substantial improvement in internal control quality (Hypothesis 1 (H1) is supported). To measure the economic significance of this result, we compare the estimated coefficient to the standard deviation of the corporate internal control quality. The standard deviation for the IC is 0.1366 in the treatment group, as shown in Panel A of Table 2, suggesting that party organization governance explains about 10.32% (0.0141/0.1366) of the variation in internal control quality. These findings indicate that party organization governance can reduce corporate violations, inhibit earnings manipulation, and curb executive on-the-job consumption, thereby improving the internal control quality in SOEs.

To analyze the premise of parallel trends between treatment and control groups and to assess the dynamic effects of party organization governance formed by the CPOPD decision-making mechanism on internal control quality, we follow Beck et al. (2010) and construct the following model:

(2)$${\mathrm{IC}}_{\mathrm{it}}={\theta }_0+\sum _{\begin{array}{c}\hfill \mathrm{k}\ge -7^{+}\hfill \\ \hfill \mathrm{k}\ne -1\hfill \end{array}}^{3^{+}}{\theta }_{\mathrm{k}}{ ({\text{ Party }}_{\mathrm{it}})}^{\mathrm{k}}+{\theta }_4{\text{ Controls }}_{\mathrm{it}}+{\mu }_{\mathrm{i}}+{\eta }_{\mathrm{t}}+{\epsilon }_{\mathrm{it}}$$

In model (2), ${\left(Part{y}_{it}\right)}^k$, a series of dummy variables, indicates the kth year of implementing the CPOPD decision-making mechanism. Specifically, ${\left(Part{y}_{it}\right)}^0$ indicates the year in which the CPOPD decision-making mechanism is implemented, where k 0 indicates the kth year before the CPOPD decision-making mechanism is implemented, and k $>$ 0 indicates the kth year after the CPOPD decision-making mechanism is implemented. ${\left(Part{y}_{it}\right)}^{\mathrm{-7+}}$ equals one for all years occurring seven or more years before the policy implementation, while ${\left(Part{y}_{it}\right)}^{\mathrm{3+}}$ equals one for all years that are third or more years after the policy implementation. According to Cherniwchan (2017), we eliminate one year before the policy implementation to estimate the dynamic effects of party organization governance on internal control quality. Other variables are consistent with the model (1).

Fig. 1 shows model (2) estimation results with 95% confidence intervals. According to Fig. 1, the coefficients of Party are insignificantly different from zero for all years before the CPOPD decision-making mechanism implementation, indicating that internal control quality was not significantly different between the treatment group and control group. In other words, we cannot reject the assumption of parallel trends beforehand. In addition, we plot the DIB internal control score divided by 1000 for the treatment and control groups to visualize changes in internal control quality in the treatment and control groups before and after the policy shock in Appendix Fig. 3. The insignificant differences between the treatment and control groups before implementing the CPOPD decision-making mechanism confirm the visual inspection of the parallel trend. Since the Chinese government issued the policy document on the CPOPD decision-making mechanism in 2015, there has emerged a difference in internal control quality between the treatment group and the control group. With the increase in the number of firms implementing the CPOPD decision-making mechanism, the difference has grown increasingly significant.

Fig. 1.

Parallel trends and dynamic effects.

Moreover, the regression coefficients of Party are significantly positive and decline steadily in the first year and the following years after implementing the CPOPD decision-making mechanism, indicating that party organization governance formed by the CPOPD decision-making mechanism significantly improves the quality of internal control, and the improvement effect decreases gradually. Hypothesis 1 (H1) is confirmed. Notably, the estimated coefficients are insignificant at the year of implementation of the CPOPD decision-making mechanism because there is a lag between the government’s promulgation of policy and the firms’ actual implementation.

We divide the sample into firms with more executive shareholding (ESM Group) and firms with lower executive shareholding (ESL Group) according to the median executive shareholding and perform a subsample analysis based on model (1). The results are displayed in columns (1) and (2) of Table 7. The coefficient of Party in column (1) is insignificant, while the coefficient in column (2) is significant at the 5% level. Party organization governance has an insignificant impact on internal control quality in firms with more executive shareholding but a significant positive effect on internal control quality in firms with lower executive shareholding. These results indicate that party organization governance plays a more significant role in improving internal control quality in firms with lower executive shareholding than in firms with more executive shareholding. Hypothesis H2 is supported.

We use the natural logarithm of the number of analysts covering the firm in the current year plus one to measure analyst attention following Zhou et al. (2024). Based on the median of analyst attention, we classify the sample firms into firms with more analyst attention (AAM Group) and firms with lower analyst attention (AAL Group). Columns (3) and (4) of Table 7 demonstrate the heterogeneity of the results by analyst attention level. The estimated coefficient of Party is insignificant in column (3), but significantly positive in column (4), suggesting that party organization governance has an insignificant effect on internal control quality in firms with more analyst attention, but significantly promotes internal control quality in firms with lower analyst attention (Hypothesis H3 is confirmed). This pattern can be explained by the fact that analyst attention has a stronger external governance role in firms with more analyst attention, diminishing the role of party organization governance in such firms. However, firms with lower analyst attention lack a robust external governance mechanism. Party organization governance can effectively compensate for the deficiency of external supervision, improve and strengthen the internal supervision system, and thus improve internal control quality.

In the context of the Chinese government’s emphasis on establishing a healthy internal control system for SOEs, we exploit the implementation of the CPOPD decision-making mechanism as an opportunity to examine the impact of party organization governance on internal control quality. We adopt a sample of A-share listed firms in Shanghai and Shenzhen from 2012 to 2022 and employ a difference-in-differences method to examine the impact and mechanism of party organization governance formed by the CPOPD decision-making mechanism in SOEs on internal control quality. We find that party organization governance significantly improves SOEs’ internal control quality. Furthermore, party organization governance improves internal control quality by reducing corporate violations, inhibiting earnings manipulation, and curbing on-the-job consumption. Party organization governance significantly enhances internal control quality in firms with lower executive shareholding but has an insignificant effect on internal control quality in firms with more executive shareholding. In addition, the positive effect of party organization governance on internal control quality is more pronounced in firms with lower analyst attention than in firms with more analyst attention.

This study provides several important theoretical implications. First, existing literature predominantly examines the economic effects of party organization governance formed by the overlap between party members and management in SOEs (Li et al., 2020; Wang et al., 2023). Few studies investigate the impact of party organization governance formed by the CPOPD decision-making mechanism on corporate governance and corporate value (Xie et al., 2022; Wang et al., 2025). However, little research explores the relationship between party organization governance formed by the CPOPD decision-making mechanism and internal control quality. We define party organization governance by whether firms amended their articles of association to implement the CPOPD decision-making mechanism and reveal the impact of party organization governance on internal control quality from both theoretical and empirical perspectives. Our research supplements the relevant literature on party organization governance and internal control quality.

Second, existing literature primarily reveals the channels through which corporate governance affects internal control quality from agency theory perspective (Li et al., 2021; Han et al., 2022). The CPOPD decision-making mechanism, as a formal institutional arrangement stipulating party organizations’ participation in SOE governance, establishes the legitimacy of party organization governance (Lin and Milhaupt, 2021). Therefore, we integrate institutional theory and agency theory to clarify the underlying mechanisms through which party organization governance affects internal control quality, illuminating the unique role of party organization governance within Chinese political institutions from institutional foundations and implementation routes.

Finally, traditional corporate governance theory, grounded in Western market environments, emphasizes internal incentives and external supervision as core mechanisms for mitigating agency conflicts and thereby enhancing internal control quality. We investigate the heterogeneous effects of party organization governance on internal control quality across different executive shareholdings (internal incentives) and different analyst attention (external supervision) within China’s unique governance system. Our findings indicate that party organization governance effectively supplements deficient internal incentives and external supervision, broadening the theoretical understanding of governance mechanism diversity within the Chinese context.

Our findings have several practical implications. First, party organization governance significantly optimizes internal control quality. Thus, the Chinese government should continue to promote and implement the CPOPD decision-making mechanism in SOEs. Lin and Milhaupt (2021) point out that the CPOPD decision-making mechanism in some SOEs is symbolic rather than substantively enforced, and the adoption rate of party organization opinions is relatively low. For example, Sichuan Provincial Investment Group Co., Ltd. failed to implement the CPOPD decision-making mechanism, resulting in inadequate supervision of major decision-making matters and a weak internal control system. The deputy general manager of the company made illegal decisions that caused huge losses to state-owned assets. Accordingly, the Chinese government should establish and evaluate specific implementation indicators for the CPOPD decision-making mechanism, such as the proportion of matters pre-discussed by party organizations and the adoption rate of party organization opinions. For SOEs with low core indicators, regulatory departments should promptly mandate rectification. Additionally, boards should alter their perception of party organization governance, recognizing that party organization participation in governance is not merely a compliance requirement, but a pivotal mechanism for enhancing internal control effectiveness, and actively facilitate the implementation of the CPOPD decision-making mechanism.

Second, the Chinese government should formulate a detailed checklist of pre-discussion items, clarify the rights and responsibilities of the party organization and management in major matters, weaken the discretionary power of executives over major matters, and reduce corporate violations, earnings manipulation, and on-the-job consumption at the source. For instance, China Nuclear Engineering lacks a clear list of pre-discussion items, resulting in ineffective implementation of the CPOPD decision-making mechanism. The proportion of expenses such as business entertainment expenses, business vehicle purchase and operation, and maintenance expenses is relatively high, with many violations. Therefore, it is crucial to formulate a detailed and enforceable pre-discussion checklist to ensure effective policy execution. Further, boards should design quantifiable indicators to regularly assess the contribution of party organizations to internal control quality through pre-discussion of “Three Major and One Large” matters. These assessment results guide adjustments to party organizations’ participation in major decision-making, such as optimizing the pre-discussion checklist.

Finally, the Chinese government should promote and improve the CPOPD decision-making mechanism based on the actual circumstances of different firms. On the one hand, for firms with lower executive shareholding, it is advisable to consider integrating internal control quality with executive compensation to incentivize executives to improve internal control quality. On the other hand, for firms with lower analyst attention, it is necessary to strengthen special reports on internal control quality and increase incentives to attract external analyst attention. Combining internal and external governance mechanisms can effectively improve internal control quality in SOEs.