Using the Internal Audit Function as a Management Training Ground: Is the Monitoring Effectiveness of Internal Auditors Compromised?
Margaret H. Christ
University of Georgia
University of Arkansas - Sam M. Walton College of Business
Nathan Y. Sharp
Texas A&M University - Department of Accounting
David A. Wood
Brigham Young University - School of Accountancy
October 15, 2012
Prior studies report that a majority of Fortune 500 companies systematically rotate internal auditors out of the internal audit function and into operational management. We examine how using the internal audit function as a management training ground affects internal audit’s ability to monitor management by examining the propensity for management to: (1) manipulate the financial reporting system as indicated by the company’s accounting risk (i.e., the risk that financial statements contain intentionally misleading or fraudulent information); (2) extract more lucrative compensation from the company; and (3) decouple compensation from performance. We find that companies that use the internal audit function as a management training ground experience significantly higher accounting risk than companies that do not. Furthermore, we find that CEOs of companies that use internal audit as a management training ground extract higher excess compensation and have lower pay-performance sensitivities than CEOs of companies that do not use this practice. Overall, our findings suggest that using the internal audit function as a management training ground can compromise internal auditors’ monitoring effectiveness. Therefore, when designing internal audit functions, firms should consider the potential costs of using the internal audit function as a training ground from which to promote managers.
Number of Pages in PDF File: 51
Keywords: internal audit function, accounting risk, executive compensation, management training ground
JEL Classification: M41, M43, G34, M52working papers series
Date posted: October 21, 2011 ; Last revised: October 15, 2012
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