The Influence of Management’s Internal Audit Experience on Earnings Management

Abstract

We examine whether firms with managers that have prior internal audit experience are less likely to manage earnings. We find that firms with managers that have internal audit experience are associated with less overall earnings management, driven by lower real earnings management. Importantly, these firms do not trade-off reduced real earnings management with increased accruals-based earnings management. Further tests reveal that this effect is generally strongest when managers with internal audit experience currently hold financial roles or roles with higher power within the company. We also confirm that real earnings management is negatively correlated with future firm performance, as measured by Tobin’s Q and abnormal returns. Overall, these results point to a potentially important benefit of manager internal audit experience, as research suggests that real earnings management is common, difficult to detect, not always within the scope of financial reporting regulators, and detrimental to future performance.