Internal Audit Competency Changes in Response to Financial Reporting Quality Failures

Limited data availability on the internal audit function (IAF) has constrained research on the topic. This study uses unique, manually collected data from LinkedIn on internal audit personnel that overcomes certain limitations of previous survey-based data. Using this longitudinal data, we test whether IAF competency is associated with financial reporting failures and whether IAF competency subsequently improves. We find that IAF competency is inversely related to the propensity for material weakness disclosures and restatements. We also find a significant increase in IAF competency in the year following material weakness and restatement disclosures. Importantly, we document that the increase in competency is not uniform across firms and is greater in firms with higher audit committee commitment toward the IAF, lower audit committee accounting expertise, and when the CFO lacks accounting expertise. These findings suggest that while there is no regulatory oversight governing the IAF, certain audit committees and executives recognize its value. Regulators that have focused on improving financial reporting quality by enhancing oversight over external auditors and audit committees should also consider focusing on the IAF