Abstract

Introduction

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Sample, Variables, and Methodology

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Abstract

The internal audit function (IAF) has become one of the main pillars of good corporate governance. Empirical findings show that the size of the IAF varies considerably across companies. This study analyzes the relationships between selected company characteristics as determinants of intra-company information asymmetries and the size of the IAF as an indicator of intra-company monitoring. We test these relationships by analyzing comprehensive survey data obtained from chief audit executives from 283 Austrian, German, and Swiss companies. Using a nonparametric regression approach, we identify significant nonlinear relationships between company characteristics and IAF size. The empirical analysis identifies threshold levels for several metric company characteristics, such as the number of employees and the number of subsidiaries, whose relationships with the size of the IAF change its intensity.

Introduction

The level of acceptance of internal auditing as a crucial element of good corporate governance has been increasingly acknowledged (e.g., Carcello et al. 2020; Eulerich and Eulerich 2020; Gramling et al. 2004). Internal auditing can be seen as “a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes” that can “add value and improve an organization’s operations” (Institute of Internal Auditors 2016). In this context, the Institute of Internal Auditors, the worldwide standard-setting body, as well as other regulating institutions, such as the United States Securities and Exchange Commission and the New York Stock Exchange, require listed companies to implement an internal audit function (IAF). While the benefits of an effective IAF are manifold and well documented in the literature, research that provides reliable empirical insights on IAF is still incomplete (DeFond and Zhang 2014; Christ et al. 2021).

We investigate from an organizational perspective whether and to what extent several company characteristics that largely determine intra-company information asymmetries are associated with different sizes of the IAF of European companies. A special feature of the empirical method applied in this paper is that it takes into account nonlinear relationships between metric company characteristics and the size of the IAF. Also, it directly estimates the effective nonlinear relationships based on the available observations. The empirical results show that there are significant nonlinear relationships between company characteristics, such as the number of employees, the number of subsidiaries, and the intensity with which different stakeholders use IAF, and IAF size. We identify threshold levels for these metric company characteristics whose relationships with the size of the IAF change its intensity. As a result, the identified nonlinear relationships create a more holistic understanding of the determinants of the size of the IAF.