Does the Presence of an Internal Control Audit Affect Firm Operational Efficiency?

Posted: 9 Mar 2023

See all articles by Andy Imdieke

Andy Imdieke

University of Notre Dame - Mendoza College of Business

Chan Li

University of Kansas

Shan Zhou

University of Sydney Business School

Multiple version iconThere are 2 versions of this paper

Date Written: October 31, 2022

Abstract

This study examines whether auditors’ evaluation and reporting of firms’ internal control over financial reporting (ICFR) affects firm operational efficiency. Prior research indicates that the strength of internal controls is positively associated with economic benefits. However, notwithstanding the underlying strength of controls, whether the mere presence of an ICFR audit provides similar economic benefits is unclear. We predict and find that small firms with ICFR audits have significantly higher overall operational efficiency than small firms with only management ICFR reports, even after controlling for underlying internal control strength. We find this effect manifests through improvements in inventory turnover and innovation, and through increased relative product market share. Separately, we find ICFR audits are associated with lower efficiency in SG&A expenses. Cross-sectional analyses indicate that the mechanism by which ICFR audits affect overall operational efficiency is through auditor detection of internal control problems and through knowledge spillover from auditing other highly efficient firms in the audit office’s metropolitan statistical area. These results provide additional evidence on the ongoing cost and benefit debate of ICFR audits for small firms.

Keywords: operational efficiency, SOX 404(b), ICFR audits

Suggested Citation

Imdieke, Andy and Li, Chan and Zhou, Shan, Does the Presence of an Internal Control Audit Affect Firm Operational Efficiency? (October 31, 2022). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4267561

Andy Imdieke (Contact Author)

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

Chan Li

University of Kansas ( email )

Capitol Federal Hall
Lawrence, KS 66045
United States
7857661277 (Phone)
66045 (Fax)

Shan Zhou

University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

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