Final answer:
Investors can have greater reliance on a firm's financial stability when the company has strong internal control systems, as these systems assure sound risk management and financial reporting. As firms grow and information becomes more publicly available, personal knowledge of management becomes less critical for investors. Internal controls, combined with limited shareholder liability and information mechanisms, build trust among outside investors such as bondholders and shareholders.
Step-by-step explanation:
Strong internal control systems are essential for businesses as they grow and their operations become more complex. These controls provide a reliable framework for managing a company's financial reporting, operational efficiency, compliance with laws and regulations, and overall performance. Well-established internal controls can give investors greater confidence in a company's financial statements, as they indicate that a business is mitigating risks and adhering to sound management practices.
For a growing firm that has shown potential for profitability, the necessity of knowing individual managers and their business plans on a personal level diminishes. This is due in part to the increasing availability of information about the company's products, revenues, costs, and profits. With this information at hand, external investors, like bondholders and shareholders, feel more secure in providing financial capital without personally knowing the management.
Furthermore, shareholder liability is limited to the amount they have invested in the corporation, making it easier for a company to raise or borrow money for expansion or other business purposes. In the financial capital market, trust is built through mechanisms that reduce the risk of imperfect information, such as reputations, guarantees, and warranties. These mechanisms, along with strong internal controls, are key to providing the assurance that outside investors seek when considering to invest in a company.