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External, In-House Internal, and Outsourced Internal Auditor Responses to Earnings Management

Fri, October 2, 12:30 to 2:00pm, TBA

Abstract

There are three types of auditors charged with ensuring financial reporting quality: external, in-house internal, and outsourced internal auditors. In an experiment with practicing auditors, we compare the responses of each auditor type to earnings management. Grounded in Organizational Identity Theory, we predict and find EAs are less likely to restrict earnings management when management’s motive to report aggressively is organization serving (i.e., to comply with a debt covenant) compared to when management’s motive is self-serving (i.e., to meet a bonus target) and compared to in-house internal auditors. Further, we provide evidence that OIAs are consistently less likely to restrict earnings management behavior compared to in-house internal auditors. Thus, our results suggest external auditors’ expressed preference to rely on the work of outsourced internal auditors over in-house internal auditors (c.f. Bame-Aldred et al. 2013) may inadvertently diminish audit quality.

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