Article2020

Can internal audit functions improve firm operational efficiency? Evidence from China

45 citations0/0 files storedManagerial Auditing Journal

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Auditing, Earnings Management, Governance Accounting and Organizational Management Corporate Governance and Financial Management

Abstract

Purpose The purpose of this study is to examine the effects of internal audit function (IAF) quality on the operational efficiency of Chinese firms. Design/methodology/approach The authors use regression models with a sample of Chinese listed companies to test their research hypotheses. Findings The authors find that IAF quality is positively associated with firm operational efficiency. The result is unchanged after correcting for endogeneity via the instrumental variable method and using an alternative measure of firm operational efficiency. The authors show that IAF competence improves firm operational efficiency, but the relationship between IAF independence and firm operational efficiency is insignificant. Additionally, they find that IAF quality can only significantly improve firm operational efficiency in the presence of effective corporate governance at the firm level and strong institutions at the province level. Using path analysis, the authors find that an IAF can improve firm operational efficiency directly or indirectly by promoting firm internal control quality. Practical implications The findings of this study suggest the need for a balance between IAF competence and independence to achieve the goals of IAF. Additionally, the authors study suggests that the effectiveness of IAF is contingent on corporate governance and market-based institutions. Originality/value The study’s findings contribute to the burgeoning literature on the relationship between IAF and firm operational performance and deepen the authors’ understanding of the role of IAF in an emerging economy whose government plays a major role in promoting and enforcing internal audits. The study also empirically support the Internal Audit Governance Maturity Model proposed by the Institute of Internal Auditors.

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References

2000Investor protection and corporate governance 2002Audit committee, board of director characteristics, and earnings management 2009How does financial reporting quality relate to investment efficiency?2003Earnings management and corporate governance: the role of the board and the audit committee 2007Politically connected CEOs, corporate governance, and Post-IPO performance of China's newly partially privatized firms☆2007A Theory of Friendly Boards 2004What Determines Corporate Transparency?2011Quantifying Managerial Ability: A New Measure and Validity Tests

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