Does Incentive-Based Compensation for Chief Internal Auditors Impact Objectivity? An External Audit Risk Perspective

Abstract

SUMMARY This paper considers the potential impact of internal audit incentive-based compensation (IBC) linked to company performance on the external auditor's assessment of internal audit objectivity. We posit that external auditors will view IBC as a potential threat to internal audit objectivity, thus reducing the extent of reliance on the work of internal auditors and increasing the assessment of control risk. The increase in risk and external auditor effort should result in higher audit fees. We hypothesize that the form of incentive-based compensation, namely stock-based versus cash bonuses, moderates the association between IBC and external audit fee. Finally, we consider whether underlying financial reporting risk mitigates the external auditor's potential sensitivity to IBC. We find a positive association between external audit fees and internal audit compensation based upon company performance. The association is acute to IBC paid in stock or stock options as opposed to cash bonuses. We also find evidence consistent with the IBC associations being mitigated by the company's financial reporting risks. Data Availability: Individual survey responses are confidential. All other data are derived from publicly available sources.

Is the type of outsourced internal audit function provider associated with audit efficiency? Empirical evidence from Oman

“…This review can have a monitoring effect (Chen, Chung, Peters, & Wynn, 2017). The current literature also argues that IAF activities can have a direct or indirect monitoring role over the financial reporting process (Abbott et al, 2016;Chen et al, 2017;Christ, Masli, Sharp, & Wood, 2015). 2 In unreported results, we observe that Big4 audit firms provide a statutory financial statement audit to 64% of our sampled companies.…”

“…Thus, the IIA () recommends that IAFs engage in the review of policies, procedures, and processes for financial reporting and disclosure. This review can have a monitoring effect (Chen, Chung, Peters, & Wynn, ). The current literature also argues that IAF activities can have a direct or indirect monitoring role over the financial reporting process (Abbott et al, ; Chen et al, ; Christ, Masli, Sharp, & Wood, ).…”

New Perspectives in Internal Audit Research: A Structured Literature Review

“…Unsurprisingly, the two main IAQ indicators that emerge from the literature are (i) the degree to which the external auditor relies on the work of the internal audit (Abbott et al, , ; Bhattacharjee et al, ; Chen et al, ; Davidson et al, ; Issa and Kogan, ; Malaescu and Sutton, ; Munro and Stewart, ; Pizzini et al, ; Prawitt et al, ; Singh et al, ), viewed as a proxy for the IAF's “work performance” (Desai et al, ; Trotman and Duncan, ), and (ii) the effectiveness of the audit committee (Abbott et al, , ; Anderson et al, ; Carcello et al, ; Christ et al, ; Davies, ; D'Onza, Selim, Melville, and Allegrini, ; Mat Zain and Subramaniam, ; Regoliosi and d'Eri, ), considered as the main proxy for independence…”

Reliance on the internal auditors’ work: experiences of Swedish external auditors

“…The IAF, with adequate competence, objectivity and work performance, can contribute to an effective external audit process (Al-Twaijry et al 2004). The latter argument would indicate that IAs could gain status and in turn legitimize the growing importance of the IAFs as a key component of corporate governance (Chen et al 2017).…”

“…However, cooperation between EAs and IAs has been assumed to be something of a double-edged sword. On one hand, EAs' reliance on and use of IAs' work can lead to efficiency improvements by eliminating the duplication of work (Morrill and Morrill 2003;Suwaidan and Qasim 2010), thus reducing the costs of the external audit and the respective audit fees (Chen et al 2017). On the other hand, close cooperation between EAs and IAs can influence the quality of the external audit (Abbott et al 2012;Pizzini et al 2015;Lin et al 2011).…”