Internal Auditor Turnover, Financial Reporting Quality, and Audit Risk Assessment

• In Event: Chief Audit Executives and Decision Making

Abstract

Internal audit serves a valuable monitoring role inside of companies; yet, we understand relatively little about factors that affect internal audit’s ability to monitor financial reporting. We study one factor—how turnover of the chief audit executive (CAE) position—influences financial reporting quality and audit risk assessment. Using a large sample of firm data from Taiwan, where companies are required to disclose when and why CAEs change position, we find that a CAE turnover event increases the odds of a of a restatement by approximately 30 percent and discretionary accruals increase by 5 percent. Furthermore, we find that the relation only holds for firms with forced CAE changes (i.e., demotions, dismissals, or resignations) and not for unforced changes (i.e., lateral moves in the company, promotions, retirements, etc.). We corroborate these findings by examining external auditors’ response to CAE turnover and find that external auditors charge approximately 4 percent higher fees the year there is a CAE change. The results provide evidence of the important monitoring role of internal auditing, and especially of the critical role the CAE plays in the internal audit function.

Authors

• Kenneth L Bills, Michigan State University

• Hua-Wei Huang, National Cheng Kung University

• Yi-Hung Lin, Monash University

• David A Wood, Brigham Young University