The Impact of Ethical Leadership and the Internal Audit Function on Financial Reporting Decisions

42 Pages Posted: 7 Feb 2011 Last revised: 15 Oct 2011

See all articles by Barbara Arel

Barbara Arel

University of Vermont

Cathy Beaudoin

University of Vermont

Anna Cianci

Wake Forest University

Date Written: February 6, 2011

Abstract

Two elements of corporate governance — the strength of ethical executive leadership and the internal audit function (IAF hereafter) — provide guidance to accounting managers making decisions involving uncertainty. We examine the joint effect of these two factors, manipulated at two levels (strong, weak), in an experiment in which accounting professionals decide whether to book a questionable journal entry (i.e., a journal entry for which a reasonable business case can be made but there is no supporting documentation). We find that ethical leadership and the IAF interact to determine the likelihood that accountants book the entry. Specifically, accountants are less likely to book a questionable journal entry when there is a weak ethical leader and a strong IAF compared to all other conditions. In addition, we find that accountants question the appropriateness and ethicalness of the request to book an undocumented journal entry more in the weak ethical leader and strong IAF condition than in the other conditions. These results suggest that the IAF has a different impact on financial reporting decisions depending on the ethicalness of executive leadership and that a strong IAF may cause accountants to question the appropriateness and ethicalness of an undocumented journal entry when combined with weak ethical leadership. We also find that the interactive effect of ethical leadership and the IAF on an accountant’s decision is fully mediated by his/her perception of the moral intensity of the issue. Thus, accountants, who perceive greater moral intensity associated with booking the entry, are less willing to do so.

Keywords: ethics in accounting, moral intensity, ethical leadership, moral action, internal audit function, financial reporting

JEL Classification: M40, M41

Suggested Citation

Arel, Barbara and Beaudoin, Cathy and Cianci, Anna, The Impact of Ethical Leadership and the Internal Audit Function on Financial Reporting Decisions (February 6, 2011). Available at SSRN: https://ssrn.com/abstract=1756284 or http://dx.doi.org/10.2139/ssrn.1756284

Barbara Arel

University of Vermont ( email )

School of Business Administration
Kalkin Hall
Burlington, VT 05405-0158
United States

Cathy Beaudoin

University of Vermont ( email )

212 Kalkin Hall
Burlington, VT 05405-0158
United States

Anna Cianci (Contact Author)

Wake Forest University ( email )

2601 Wake Forest Road
Winston-Salem, NC 27109
United States

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