Internal Audit Competency Changes in Response to Financial Reporting Quality Failures

Abstract

Limited data availability on the internal audit function (IAF) has constrained research on the topic. This study uses manually collected data from LinkedIn of internal audit personnel that overcome certain limitations of previous survey-based data. Using this longitudinal data, we find that IAF competency is inversely related to the propensity of material weaknesses and misstatements. We also find that IAF competency improves in the year following material weakness and restatement disclosures. Importantly, we document that the increase in competency is not uniform across firms and is greater in firms with longer auditor tenure and higher audit committee accounting expertise. These findings suggest that while there is no regulatory oversight governing the IAF, certain auditor and governance characteristics influence its value. Regulators that have focused on improving financial reporting quality by enhancing oversight over external auditors and audit committees should also consider focusing on the IAF.

Keywords: Internal Audit Function, Internal Audit Competency, Financial Reporting Quality, Material Weakness Disclosure, Restatements, LinkedIn

JEL Classification: M40, M41, M42