Internal Control Quality and Audit Effort: Does the CIO Matter?

• In Event: Internal Controls

Abstract

This study investigates the influence of the Chief Information Officer (CIO) on the quality of internal controls over financial reporting and on external auditors’ level of effort. Recent research has shown that top executives other than the CEO and CFO can influence financial reporting quality, and, as the highest level IT executive or manager in the firm, the CIO plays a distinct role in establishing a firm’s internal control environment. This role is arguably second in importance only to that of the CEO and CFO, given that accounting processes are routinely electronic and weak IT controls have been found to negatively affect financial reporting quality. CIOs also manage overall IT operations, including system selection and implementation. IT systems can influence reporting quality by facilitating—or, alternatively, impeding—performance of the annual audit. An influential CIO can also impact audit efficiency by providing a high quality internal information environment, characterized by useful, accurate financial reports and up-to-date IT systems documentation.
Using logistic analysis of a matched sample of 385 firms, I find that those with CIOs in the top management team are significantly less likely to receive a report of ineffective internal controls over financial reporting under SOX 404. I employ simple OLS regression analysis and a sample of 4,948 firm-year observations from 2004-2014 and find that audit effort, measured as audit fees and audit delay, is higher for firms with a highly compensated CIO, driven by firms in industries experiencing a high-level of IT-driven change. These results provide evidence that, while CIOs are associated with better overall internal control quality, the promise of better audit efficiency through sophisticated IT system controls may not have been realized. Alternatively, higher audit effort in firms with a highly compensated CIO may reflect higher client demand for monitoring in firms with greater complexity or risk. Finally, it may be that expectations regarding internal control-based audit efficiencies are unrealistic in practice.
This study adds to the relatively limited prior research regarding the role of individual executives on financial reporting quality and is the first to my knowledge to examine the role of the CIO. Second, it adds to extant research on audit effort by identifying additional firm- and industry-level characteristics associated with audit fees, including the presence of a CIO in the top management team.

Author

• Jean R. Bradley, University of Texas-San Antonio