Abstract
The purpose of this study is to explore the argument that Chief Executive Officer (CEO) involvement in the appointment of the Chief Auditing Executive (CAE) is detrimental to efforts to achieve good financial reporting quality (FRQ). The study is original in that to date, this precise link has not been investigated. Data are obtained via survey and annual reports relating to 307 UK companies listed on the London Stock Exchange, and the working capital and discretionary accruals are used as proxies for financial reporting quality. The findings support the contention that the benefits to FRQ of an independent and competent internal audit function are not realized when there is CEO involvement in the appointment of the CAE, since management is able to override IA controls. Indeed, high FRQ is only evident when the CEO is not involved in the appointment. The results are found to be robust after using two different methods of estimation, and carry the implication regulators concerned with FRQ and quality of internal audit function that the CEO should not be party to the appointment of the CAE since this will depress FRQ.
Highlights
The influence of internal audit (IA) competency and independence and financial reporting quality (FRQ) has been confirmed by several researchers
The assumption is made in this study, that those companies reporting greater IA independence and competency, will report greater FRQ, and that companies operating with independent nomination committees likewise benefit from greater IA independence and competency, and better FRQ
The logical conclusion to draw is that IA independence and competence, and FRQ are diminished when Chief Executive Officer (CEO) involvement is apparent in the Chief Audit Executive (CAE) appointment
Summary
The influence of internal audit (IA) competency and independence and financial reporting quality (FRQ) has been confirmed by several researchers (see for example, Abbott, Daugherty, Parker, & Peters, 2016; Prawitt, Smith, & Wood, 2009). It would seem to be imperative for IA to be endowed with such independence and competence With this in mind, the purpose of this study is to explore the issue of Chief Executive Officer (CEO) involvement in approving and appointment of the Chief Audit Executive (CAE), addressing whether such involvement operates to lessen internal audit quality (IAQ), FRQ. The independence and competence of the IAF is widely acknowledged to be essential in securing good corporate governance, part of which is the provision of good FRQ Such recognition is enshrined in the internal audit standards issued by the Institute of Internal Auditors [IIA] (2017) which emphasize both the necessity for IA to enjoy independence from general management, and for the CAE to report to an organizational level that facilitates the fulfilment of IA obligations. This would require a suitably qualified CAE appointed him/herself by a suitably constituted AC
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