Factors affecting the voluntary use of internal audit: evidence from the UK

Abstract

Purpose This study aims to identify the factors that lead non-financial companies listed in the UK to use an internal audit function (IAF) as a monitoring mechanism. Although the use of an IAF in the UK is voluntary, no prior research has examined the drivers for using one. Design/methodology/approach Financial and non-financial data were collected from the annual reports of 332 UK non-financial companies listed on the London Stock Exchange (LSE) Main Market. Univariate tests and multivariate logistic regression tests were used to test the research hypotheses. A theoretical framework based on both agency theory and transaction cost economics (TCE) theory was used to explain the economic factors affecting the use of an IAF. Findings The study provides evidence that firm size, level of internal risks, agency problem between owners and managers and existence of an effective audit committee are associated with the existence of an IAF. Thus, the need to have strong internal control and risk management systems and to reduce both internal and external agency costs drives companies to have an IAF. These results suggest the importance of IAF as an internal corporate governance tool and the effectiveness of UK governance regulations in monitoring the effectiveness of internal control systems. Practical implications Given the importance of the IAF’s corporate governance role, the study provides some policy implications. Regulators should pay more attention to the issue of maintaining an IAF, especially by large companies, the relationship between the IAF and other governance parties, especially the audit committee, and the disclosure of more relevant information about the IAF’s characteristics and practices. Originality/value This is the first study to examine the factors affecting the existence of the IAF within the UK’s distinctive regulatory approach of “comply or disclose reasons”. Furthermore, it provides a theoretical framework that explains how both the agency theory and TCE theory can interpret the adoption of internal audit.

The Impacts of Investment in Internal Audit Functions on the Going Concern Opinion for Financially Distressed Firms

“…The second stream of literature reviewed in this study is related to the internal audit function. Many studies have focused on outsourcing the internal audit function (e.g., Barr-Pulliam 2016;Abdolmohammadi 2013;Anderson et al 2012;Carey et al 2006;Ismael 2018;Davidson et al 2013;Bartlett et al 2015). For instance, Barr-Pulliam (2016) shows that approximately 38% of organizations around the world have outsourced their internal auditing functions.…”

“…Other studies on the formation of an internal audit function have focused on its determinants. Ismael (2018) investigated those factors that influence the voluntary use of internal audit. By using a sample of 332 UK non-financial companies listed on the London Stock Exchange Main Market, they found that those factors associated with the formation of an internal audit function include firm size, risks, agency problem, and effective audit committee.…”

The Effect of Audit Committee Characteristics on Audit Quality: The Moderating Role of Internal Audit Function

“…Both IAF and AC bond the relationship between principals and agents under the agency theory. Under the agency theory, IAF and AC are recognized as a bonding function borne by the senior managers (agent) of an organization to monitor their behaviour to ensure the interests of the shareholders (principal) of an organization are being served and protected (Ismael & Roberts, 2018). Most organizations will employ internal auditor and non-executives' directors together with the service of an AC as internal monitoring mechanisms.…”

The Effect of Audit Committee Characteristics on Audit Quality: The Moderating Role of Internal Audit Function

“…If the relationship between the principals and the agents are utility maximisers, there is always costs incur in monitoring and bonding in order to reduce agency problem (Jensen & Meckling, 1976). The IAF is important as an internal corporate governance tool and to provide assurance on the effectiveness of the internal control and risk management control systems in order to reduce both internal and external agency costs (Ismael & Roberts, 2018).…”