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

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).