The Effects of Internal Audit Report Disclosure on Investor Confidence and Decisions

Abstract

While reporting requirements increase transparency about management,
the audit committee, and the external auditor, there are no required disclosures
relating to a company’s internal audit function. This study evaluates whether the
inclusion of an Internal Audit Report (IAR) increases investor confidence in
financial reporting reliability. The study also investigates whether company fraud
risk affects use of the IAR. Seventy undergraduate business students acting as
surrogates for nonprofessional investors participated in a 2  2 experiment with
internal audit disclosure and fraud risk randomly manipulated between subjects.
The results indicate that providing an IAR in management’s financial information
increases investor confidence that reported financial information is free from both
errors and intentional misstatements. The interaction results reveal that the IAR
effect on investor confidence significantly differs for companies with high fraud risk
than those with low fraud risk. Finally, self-insight results show that participants
found the External Audit Report (EAR) to be significantly more useful in decision
making when an Audit Committee Report is given (in addition to EAR) than when
an IAR is disclosed (in addition to EAR).