Research On Interaction Between Internal Control Quality And Audit Risk

Chinese enterprises listed overseas started to initiate internal control based on SOX Act in 2004,since then,the internal control system has developed over ten years in China.Along with the issuance of "Internal Control Standards" in 2008,the full implementation of "Internal Control Guidelines" among the companies listed in Shanghai and Shenzhen Stock Exchange in 2012 symbolized that the internal control system of Chinese enterprise has been preliminarily built.The internal management demand of enterprises and the inspections of the external investors and auditors have always played an important role in internal control development,which also promote the evolution of internal control theory.Both the SOX Act and “Internal control standards” specify the duties of management in internal controland strengthen the supervision role of external auditors.Hence,the quality of internal control is closely related to top management team and external audit.As the starting point of internal control,the top management team is an important bridge of internal management and external audit.However,there have been few studies analysing the key role of top management team between internal control and external audit.As a consequence,this study analyzes the interaction between internal control and external audit under the influence of top management team characteristics.Based on the asymmetric information theory,contract theory and deep pockets theory,this study redefines internal control quality and external audit risk,using audit fee and audit opinion as the proxy of audit risk.Based on optimization theory and auditing risk theory,this study integrate internal control quality and the auditor firm organization form into audit pricing model.Based on equilibrium solution and comparative static analysis of the theoretical model,this study proposes lemmas regarding the effect of internal control quality and auditor firm organization form on audit risk.Empirical results show that,internal control quality is negatively related with auditing risk,i.e.,companies with internal control deficiency are charged with higher auditing fees,and are more likely to receive modified auditing opinions.Further research reveals that audit firms with partnership organizational form charge higher audit fees than limited liability audit firm,and audit fees increase after the organizational form of audit firms change from limited-liability to special generalpartnership(limited liability partnership)after the year 2010.Based on the interaction of the internal control and external audit,this paper further analyzes whether external auditing plays a role in affecting the internal control system quality of listed firms in China.The empirical tests are conducted through examining the effect of modified audit opinion on internal control quality in the following year.Empirical results prove that,for the listed companies which have disclosed internal control deficiencies,if they received a modified audit opinion in the previous year,the probability of remediation of internal control deficiency is higher.Further study shows that,after the remediation of internal control deficiency,firms do not receive a clean audit opinion immediately,reflecting remediation of the deficiencies in these companies may float to the surface,which is not effective.By combining the human resources theory with the related theory of accounting and auditing,this paper adds characteristics of top management team as moderating variables in order to further investigate the interaction between internal control quality and external audit risk.Management characteristics are divided into homogeneous and heterogeneous characteristics based on upper echelon theory.Empirical analysis indicates that management characteristics moderate the relation between internal control and external auditing.More specifically,team size,average age,average tenure and average degree of management team generate significantly positive impact on the relationship between internal control quality and audit risk.The heterogeneity of age,educational levels and tenure generate negative impact.Current and relevant research mainly focused on the effect of internal control on external audit through empirical method,rarely studied the effect of external audit on internal control quality in the following year,and ignored the role of top management team.This paper investigates the interactions between internal control and external audit in depth,which enriches existing theory and empirical research about internal control and external audit.Moreover,this paper have introduced the characteristics of top management team as moderating variables based on organizational management.Therefore,this study can combine the theory of human resource with accounting and audit effectively,which can provide new idea in the arrangement of human resource and a theoretical basis of the cross research about human resource and accounting.