Internal and external audit substitution.

摘要

This dissertation investigates the relationship between a business firm's allocation of resources to its internal audit department and the expenditures it makes on external audit services. An overall substitution relationship is hypothesized with the greatest degree of substitution being hypothesized for those firms in which the internal audit department reports to the top organizational levels in the firm. This result is expected because raising the level of the internal auditors within the firm increases their autonomy from the activities overseen and the likelihood that they will report any errors found. This increased probability of disclosure increases the perceived quality of the internal auditors and, thus, their usefulness as an external audit substitute.;A total audit cost model of the firm consisting of two simultaneous equations is presented. The first equation explains internal audit department costs in terms of financial and non-financial variables. The second equation explains external audit fees in terms of financial variables and the firm's internal audit expenditures. Two-stage-least-squares regression analysis is used to estimate the two-equation model.;A sample of 106 large publicly-held U.S. firms was examined. Of these, 61 had the internal auditors report above the corporate Controller and 45 had the internal auditors report below the Controller. Significant substitution was predicted for the 61 above-Controller firms and not for the others.;The hypotheses are supported by the results. The audit substitution effect shows at the margin when all financial and non-financial factors in the firm have been controlled. In addition, the extent of audit substitution is a function of the level in the firm to which the internal auditors report.;These results support the principal-agent view that internal and external auditing are competing mechanisms in the operation of the firm. The results also indicate that the internal administrative structure of the client firm can affect the pricing of audit services by independent CPAs. Finally, the audit substitution effect is shown to be a complex relationship in which the quality and autonomy of the internal audit department are important.