Abstract
Outsourcing the internal aud it function (IAF) is a worldwide practice attractive to companies, practitioners and regulators because it is believed that providers of this function are objective and competent and can provide high-quality audit. This study explores the potential influence of company and auditor characteristics on selecting outsourced IAF providers with industry expertise. Using 334 observations for non-financial companies that outsourced this function to an external provider over the period 2010–2017, logistic regression suggests that company characteristics such as size, issue of new equity, age, and total accruals significantly determine the selection of industry-expertise outsourced IAF (IEOIAF) providers. We report similar findings when considering alternative approaches for measuring industry expertise, using a matching sample method, and controlling for the potential effect of endogeneity. In additional analysis, we explore these determinants, classifying the IEOIAF providers into big4 or second-tier audit firms; we find that size, leverage, quick ratio, concentrated ownership, loss, assets turnover, age, total accruals, external auditor type, and audit fees are the major determinants in the choice of an IEOIAF provider. Our study is of interest to a variety of users and provides the first empirical evidence for the determinants of outsourced IAF providers with industry expertise.
Highlights
Over the last two decades, requiring public companies to establish an internal audit function (IAF) has become the norm in many capital market authorities worldwide
For second-tier audit firms, we find that the coefficients on leverage, concentrated ownership structure, assets turnover ratio, age, and big4 as external auditor are positive and significant, suggesting that companies with high debt ratio, concentrated ownership, high assets turnover, and big4 audit firms as external auditors are more likely to select outsourced IAF providers who are second-tier with industry expertise
We adopt factors related to company and external auditor characteristics as the determinants, since research on external auditor choice documents that these characteristics play a significant role in selecting an auditor with industry expertise
Summary
Over the last two decades, requiring public companies to establish an internal audit function (IAF) has become the norm in many capital market authorities worldwide. Company-specific characteristics According to the theories adopted by this study (agency and signalling), several factors related to the company may explain the incentives for selecting an industry-expertise external IAF provider These characteristics, reflecting size, complexity, and risks, are reported to influence the selection of high-quality auditors (DeFond & Zhang, 2014), and the decision to internalise or externalise this function (e.g., Abbott et al, 2007; Baatwah & Al-Qadasi, 2020). We state the following hypothesis: H6: External audit fees are positively associated with outsourced IAF providers who have industry expertise
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