The Effect of Incentive‐Based Compensation on Internal Auditors' Perceptions of Objectivity

Abstract

A key threat to internal audit objectivity is the payment of incentive‐based compensation (IBC) to internal auditors. This study uses an experimental approach to examine whether IBC paid to internal auditors based on company performance and individual performance does impact their objectivity. The study also investigates whether the cultural background of internal auditors affects their objectivity in the context of IBC by examining whether those from an individualist culture (Australia) differ in their responses to those from a collectivist culture (Malaysia). The descriptive results suggest that IBC is awarded to both internal auditors/chief audit executives in Australia and Malaysia. The experimental results indicate that IBC is a threat to internal auditors' objectivity when it is based on company performance, but is less of a threat when it is based on individual performance. Culture does not appear to impact perceptions of internal auditors' behaviour but does affect perceptions of the appropriateness of adverse behaviour.

Keywords: Internal audit, objectivity, incentive‐based compensation, economic interest threat, culture