When Does the Internal Audit Function Enhance Audit Committee Effectiveness?

Abstract

ABSTRACT I examine whether audit committees (ACs) improve financial reporting reliability by utilizing an internal audit function (IAF) as a resource and use semistructured interviews with chief audit executives and AC chairs to develop an understanding of the nature of AC-IAF relations. Using AC charters, I measure AC interaction with IAFs, finding improvement in financial reporting reliability for firms that introduce a new IAF under a New York Stock Exchange (NYSE) mandate. This improvement is limited to firms with significant interaction between ACs and new IAFs. Using detailed hand-coded data, I investigate the different kinds of interactions between ACs and IAFs, finding evidence of the importance of private meetings to review the IAF's scope, findings, and recommendations. The value of the IAF as a resource to the AC is greater when the AC ensures free and open communication, promotes IAF independence, and stands in greater ex ante need of monitoring assistance. JEL Classifications: G39; M40; M41.

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