Can Internal Audits Reduce Financial Penalties? Th

Nowadays, the importance of internal audit function is gradually raised by practice. NYSE requires all listed companies maintain internal audit function, while SEC issues SOX that set strict standard of internal control. In China, regulators suggested companies build up internal audit function previously, now they force all listed companies to maintain internal audit function. However, we need more insight into internal audit to full use of it.Empirical studies about internal audit function are really limited, especially in China. The prior studies didn’t come to a consensus conclusion and an acknowledged paradigm, while the shortcoming of data and method is another concern. So related research which can provide evidence for policy setting and adjustment, is in urgent demand.CSRC launch a corporate governance review in2007, in this review, all listed firms need to report internal audit status, and is required to rectify timely. So what are the determinants that influence companies whether to introduce internal audit? Does internal audit play a favorable role to enhance corporate governance as expected? Why some companies rectify in time, while some do not? Does the governance effect differ between proactively and passively born internal audit function?In order to answer these questions, I examine the determinants and economic consequences of internal audit function in voluntary and mandatory settings respectively. Or, more specifically, I examine if internal audit function can reduce financial violationFirstly, I find the existence of audit committee is significantly related to existence of internal audit function in voluntary setting. Meanwhile, size presents a positive relation with internal audit while growth and marketization index display a negative relation significantly. In mandatory setting, SOEs significantly rectify inactively than non-SOEs.Moreover, my findings indicate a significant negative relation between internal audit function and financial violation in voluntary setting, which means internal audit function can bring positive effect to companies. However, I don’t find similar relations in mandatory settings. Thus, an effective internal audit function needs favorable environment and strong support. Also, I find companies with high percentage of independent directors violate more significantly. That is, independent director system doesn’t bring favorable influence to companies as expected by regulators.This paper is the first to examine relation between internal audit and financial violation in China. My comparison between voluntary and mandatory setting indicate that firms may distort in external-driven setting, which is also a reference for regulators. Finally, I enhance research method by using of a unique database which is disclosed compulsively and free of sample bias.