The association between firm characteristics and the quality characteristics of the internal audit function in the UK: an agency perspective

Abstract

This study investigates firm characteristics that may affect the IAF's quality characteristics: size, independence, methodology, and competence. Its motivation is that a firm's agency and economic costs can affect its way to invest in the IAF quality. In this study, a postal questionnaire survey was sent to the head of internal audit (HIA) in 213 UK non-financial companies with in-source IAF, and archival data were collected from the respondent companies' annual reports. The study found that a firm's size and the proportion of cash flows from its operations are positively associated with the IAF's quality characteristics, a suggestion that a high quality IAF is an important way of compensating for the direct loss of control and of managing internal agency risks. In addition, it found evidence that having a high quality IAF is a costly process; the level of debt had a significant negative association with the IAF's quality characteristics. Furthermore, the supporting OLS regression revealed a positive significant association between the effectiveness of the audit committee and the quality characteristics of the IAF. This study has important implications for both practice and future internal auditing research and provides a composite measure that can be used to assess IAF quality.