A Mechanism Research And Empirical Test On Internal Auditing In Corporate Governance

In Enron and WorldCom cases, the internal auditing would undoubtedly become the focus of attention. The promulgation of"Sarbanes-Oxley Act"in the U.S., and the rules of the New York Stock Exchange requiring all listed companies to establish internal audit function, as well as the introduction of the Higgs Report (2003), Smith Report (2003), the revised"comprehensive guidelines for corporate governance (2003)"and other new regulatory requirements in the United Kingdom, also raised the importance of internal auditing in corporate governance. The audit profession accepts following points of view: the internal audit function (IAF) plays an important role in corporate governance and the good corporate governance is composed of four"cornerstone": the IAF and board of directors, senior management, external auditing. However, these questions: how do the internal auditing play a role in corporate governance, what is their establishment motivation, and which are the influencing factors of internal auditing under the different models, and different ways to carry out internal audit function, in turn whether these internal audit function has improved the quality of governance and so on. It seems to be lack of adequate theoretical support and empirical test. Therefore, the answers to these questions will further raise awareness on the internal auditing in corporate governance role, enrich and expand the internal audit research, strengthen the internal auditing practice and improve corporate governance. This has important theoretical and practical significance.Based on accountability theory, principal-agent theory, transaction cost theory and corporate governance theory, the paper is built an analysis framework of the internal auditing role in corporate governance, the internal auditing functions will play a governance role by the collaboration with"the other three governance subjects". At the same time the paper builds up a game model, the numerical simulation results show that: when the company control risk is low, the company will tend not to set up internal auditing functions; when control risk is relatively higher, the company will set up it's internal auditing functions; but when control risk is large, The company will choose some of the internal audit partial outsourcing or total outsourcing.In this paper , combining China's institutional context , using research opportunities of disclosing internal audit information in the corporate governance of listed companies to the report of the special self-examination, we used the financial data and transaction data of Shanghai and Shenzhen A shares in 2007 to study: The establishment motivation of internal auditing, influencing factors of internal auditing under the different models and different ways to carry out internal audit function, as well as from the audit fees, audit quality and the market reaction to test the governance effects of internal auditing.Empirical studies results show that: (1) the main influencing factors which effect China's listed companies to establish internal audit function include: the establishment of the Audit Committee or not, independent director ratio, degree of market competition, company size, company risk factors. When the company established the Audit Committee , greater independent director ratio , more intense market competition, larger companies, greater enterprise risk, then the company would be more likely to establish internal audit function. (2)The main influencing factors which effect companies to set the internal audit functions under which modes is: competitive market environment, firm size and audit committee to establish whether or not. If the larger firm, established the Audit Committee, the more likely it will be located in the internal audit function under the Board of Directors. Another example, if the lower shareholder equity ratio and larger firm size, companies may even be located at Board of Supervisors. But when the larger firm sizes, the more intense market competition, the more likely it is to establish the internal audit function under the general manager. Only when the smaller firm sizes, the lower independent director ratios, it will be located in the financial subordinates. (3) To different ways of the internal audit function, the main influencing factors in the practical implementation include: agency costs, transaction costs (dedicated internal audit of assets and internal audit activities, frequency), the Audit Committee the effectiveness. And the higher agency costs of the company, the lower internal audit-specific nature of the assets, the less frequent the internal audit activities, the Audit Committee was not set up or no effective , the more companies would likely to conduct an internal audit outsourcing. (4) The internal auditing has a governance effect. The establishment of internal audit function will bring listed companies relatively low external audit fees, and can actually increase the company's audit quality, and the response from the market, the company's setting up internal audit institutions can increase investors'anticipation on improving corporate governance effect, they are expected to actively buy the company's shares, thereby induces the higher abnormal returns of stock. To governance effect in different modes of internal auditing, from external audit fees and audit quality, two internal auditing modes under the Board of Directors or Audit Committee and the General Manager have a significant governance effect, but to the identity of investors, investors will prefer the mode of internal audit under the board of director model. But to governance effect in different performing mode of internal auditing, only the internal auditing partial outsourcing can significantly reduce external audit fees, improve the quality of audits, and from reactions in the market, only the adoption of internal auditing partial outsourcing has a significant effect, that is, internal audit and external audit co-operation will bring higher audit quality, and can increase investors'confidence to the effectiveness of corporate governance.The analytical framework of governance role of internal auditing is built, as well as the game model, this will deeply help to understand role mechanisms of the internal auditing in the governance and provide a solid theoretical support. At the same time, this research is a valuable attempt in empirical research of internal audit function. From the empirical point of view, the combination with internal auditing practices and corporate governance practice, this paper will explore and put forward policy recommendations: (1)Actively establish company's internal auditing functions. If companies establish the internal auditing functions, the external auditing fee will become relatively low and it can improve the company's auditing opinions, and that can increase investor's confidence in the market reactions for the effectiveness of corporate governance, it also shows that the internal auditing has become more corporate governance effect. (2)Companies need establish the internal audit functions, the best model of advocacy of internal audit should be functionally under the Board of Directors and Audit Committee, and report to the General Manager in the executive report. (3) The way to carry out internal audit function should take partial outsourcing, namely, internal audit staff and external auditors cooperate in the implementation in internal auditing functions, That can result in better governance results.