Dean’s Research Seminar November 10, 2006

1. DETERMINANTS OF INTERNAL AUDIT FUNCTION PERFORMANCEByDr. Douglas E. Ziegenfuss*Old Dominion UniversityDr. Patricia M. Myers Brock University Dr. Wayne K. Talley, Old Dominion University Dean’s Research Seminar November 10, 2006

2. Synopsis • This study examines the relationship between Internal Audit Function (IAF) and the following independent variables: • IAF relative size, • IAF resources, • IAF staff quality, • IAF quality assessment review completion, • audit committee effectiveness, • Chief Audit Executive (CAE) reporting relationships, • IAF interaction with external auditors, • reporting year, and • organization demographic variables such as industry and headquarter country.

3. Why Is This Research Important? • Sarbanes-Oxley Act Section 404 requires CEO and CFO to attest to the adequacy of their organization’s internal control system. • In most cases, Executives are relying on IAFs to fulfill this responsibility. • Government entities have a similar responsibility under Generally Accepted Government Auditing Standards (Yellow Book). • The organization’s external auditors must perform an attestation engagement affirming that the organization’s internal control system is adequate. • The organization’s external auditor cannot assist the Executive because the assistance would violate their independence.

4. What is Internal Auditing • Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations.  It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.

5. Internal Auditing • Usually located within an organization but may be outsourced. • BIG 4 and other outsourcers are biggest sponsors of the IIA’s annual conference. • Internal Auditing is considered the fourth leg of an organization’s four legged governance structure: • Audit Committee of Board of Directors • External Auditor • Internal Auditor • Management • Internal Auditing has been “Hot” for he past 4 years. • Not only in the US but also globally. • Membership in the IIA has gone from 60,000 in 2000 to 115,000 in 2006. • Careers have taken off spectacularly!

6. Internal Audit Research • The Institute of Internal Auditors Research Foundation (IIARF) and Academic Relations Committee (ARC). • Tries to entice Universities and Colleges to adopt internal auditing into their curriculums • Promotes academic research into Internal Auditing topics through grants. • For instance, IIARF will fund Doctoral Dissertations for $10,000 dealing with internal audit.

7. Research Opportunities in Internal Auditing (ROIA) • Edited by Andrew Bailey, Audrey Gramling, and Sridhar Ramamorti. • Leading auditing scholars authored chapters in ROIA dealing with issues affecting IAFs such as corporate governance, IAF management, risk assessment, etc., • Each author presented previous literature and then posed questions for future researchers. • Prawitt (2003) and Lemon and Tatum (2003) wrote chapters especially relevant to this study.

8. IAF Performance Studies • Lampe and Sutton (1994) developed a method for IAFs to establish quality measuring systems. • Gupta and Ray (1992) investigated the role that IAFs could take in their organization’s total quality improvement process. Finally, Frigo (2002) demonstrated how IAFs could implement a balanced scorecard framework to measure their performance. • Ziegenfuss (1998): • (1) reviewed the Global Internal Auditing Network (GAIN); • (2) identified seventy-two potential performance measures that IAFs could use; • (3) conducted a survey of CAEs to identify those performance measures actually used; and • (4) developed an index to measure IAF performance. • Ziegenfuss (2000a) also proposed an IAF balanced scorecard and (2000b) published the results of the CAE survey.

9. IAF Performance Studies(Continued) • Applegate, (1997) described the non-traditional performance measurement process at the Boeing Aircraft Corporation. • Beeler, (1999) examine the factors associated with internal auditor promotion probabilities. • Williams (2000) identify the efficiencies associated with value-added auditing. • Reding (2000) benchmark the Allstate Insurance Company’s IAF against the IIARF’s Competency Framework for Internal Auditing study. • Brierley (2001) study the factors that prevented the establishment of an IAF in the Sudanese public sector. • Nash and Flesher (2001) sampled the middle 400 companies from the Fortune 1000 to identify performance measures currently being used by IAFs.

10. IAF Performance Studies(Continued) • Felix (2001) research the contribution of internal audit as a determinant of external audit fees and the factors that influenced this contribution. • Lampe and Garcia (2003) present the current state of professionalism among internal auditors. • Moeller (2004) describes how to manage an IAF after SOX. • Carcello (2005a) investigate the factors associated with U.S. public companies’ investment in internal auditing. • Carcello (2005b) study the changes in IAF during the time of the major U.S. accounting scandals. • Rittenberg and Anderson (2006) discuss hiring and inspiring a CAE.

11. What is lacking? • An exploratory study to determine what factors influence IAF performance.

12. Research Question • We propose that IAF-PERFORMANCE varies with • inputs IAF-INPUTS, • organizational governance ACCHARTER and ACCOUNTABLE, • IAF reporting arrangements with management ADREPORT AND FUNREPORT, • IAF-Board reporting arrangements QUALCOMM and FREQUENCY, • IAF relationship with its organization’s external auditor COORDINATION, • organizational characteristics, such as industry PIC, headquarters country USA, and GAIN reporting year RYEAR i.e.,

13. Research Question(Continued) • IAF-PERFORMANCE = • f (IAF-INPUTS, ACCHARTER, ACCOUNTABLE, ADREPORT, FUNREPORT, QUALCOMM, FREQUENCY, COORDINATION, PIC, USA, REPORTING YEAR) (1)

14. Variable Definition and Measurements

25. Global Auditing Information Network (GAIN) • SAMPLE SELECTION • The IIA began GAIN in the mid-1990s as a benchmarking tool for CAEs. • Initially, few IAFs participated in GAIN due to several factors: • (1) CAEs were unfamiliar with it, • (2) the paper and pen format of the early years was inconvenient to complete, and • (3) GAIN’s high annual fee. • However in 1999, GAIN became internet based and the IIA dramatically reduced the annual fee. • Participation greatly increased from 438 respondents in 1998 to 747 in 2003. • We selected 168 IAFs who responded in each of the five years being studied.

26. TABLE 2: REGRESSION RESULTS (Report-Time as dependent variable) Ordinary Least Squares Regression Model test: F[ 14, 625] = 9.61, Prob value = .0000 Fit: R-squared = .177, Adjusted R-squared = .159 * = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

27. TABLE 3: PROBIT ANALYSIS RESULTS (Addvalue as dependent variable) Ordered Probit Model Iterations completed: 13 Log likelihood function: -449.3665 Restricted log likelihood: -472.0351 Chi-squared: 45.33711 Degrees of freedom: 7 Significance level: .0000 Cell frequencies for outcomes: Panel B: Ordered Probit Model * = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

28. TABLE 4: PROBIT ANALYSIS RESULTS (ReportQual as dependent variable) Panel A: Ordered Probit ModelSatistics Iterations completed: 17 Log likelihood function: -412.9412 Restricted log likelihood: -443.1573 Chi-squared: 60.43224 Degrees of freedom: 10 Significance level: .0000 Cell frequencies for outcomes: Panel B: Ordered Probit Model * = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

29. TABLE 5: TESTS OF SIGNIFICANCE SUMMARY * = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

30. TABLE 5: TESTS OF SIGNIFICANCE SUMMARY * = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

31. Conclusions We draw the following conclusions: • IAFs appear to be benchmarking their performance within the industry in which their organizations operate, • Administrative and to a less extend functional reporting arrangements appear to influence IAF audit performance, • Experience and professional certification seem to affect IAF performance particularly with respect to auditee ratings, • SOX did not have a significant influence on IAF performance, • Whether the organization was headquartered in the USA or elsewhere only marginally influenced IAF performance, and as did the employee to auditor ratio, and corporate governance.