The Effect of Using the Internal Audit Function as a Management Training Ground on the External Auditor's Reliance Decision

TLDR

Over half of companies with an internal audit function hire auditors for short stints before promoting them to management, using the IAF as a management training ground. This study examines how using the IAF as a management training ground influences external audit fees and auditors’ perceptions of the IAF. An experiment demonstrates why firms that use the IAF as a training ground incur higher audit fees. Archival data show that such firms pay higher external audit fees, and auditors view those internal auditors as less objective but equally competent, highlighting important implications for companies. Data are available upon request but are subject to restrictions by the Institute of Internal Auditors Research Foundation.

Abstract

ABSTRACT This study examines how using the internal audit function (IAF) as a management training ground (MTG) affects external audit fees and the external auditors' perceptions of the IAF. Over half of all companies that have an IAF specifically hire internal auditors with the purpose of rotating them into management positions (or cycle current employees into the IAF for a short stint before promoting them into management positions). Using archival data, we find that external auditors charge higher fees to companies that use the IAF as a MTG. Using an experiment, we provide evidence as to why fees are higher. Specifically, we find that external auditors perceive internal auditors employed in an IAF used as a MTG to be less objective but not less competent than internal auditors employed in an IAF not used as a MTG. These results have important implications for the many companies that use their IAF as a MTG. Data Availability: Contact the authors. Data provided by the Institute of Internal Auditors Research Foundation are subject to restrictions.