Does the supervisory ability of internal audit executives affect the occurrence of corporate fraud? Evidence from small and medium-sized listed enterprises in China

• Pages: 1-26
• Date: 20 August 2020
• DOI: https://doi.org/10.1108/IJAIM-02-2020-0020
• Published date: 20 August 2020
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Huixiang Zeng,Li Yang,Jing Shi

Does the supervisory ability of

internal audit executives af‌fect

the occurrence of corporate fraud?

Evidence from small and medium-

sized listed enterprises in China

Huixiang Zeng and Li Yang

School of Business, Central South University, Changsha, China, and

Jing Shi

School of Economics and Management,

Lanzhou University of Arts and Science, Lanzhou, China

Abstract

Purpose –Internal audit executivesinstruct the internal audit department to supervise corporate business

management activities, evaluate internal controls and risks and provide recommendations for operating.

Therefore, this paper aims to conf‌irm whether and how the supervisory ability of the chief internal audit

executive enhances the internalaudit department’s function to prevent corporate fraud.Based on the results,

this paperfurther researches the role of the supervisoryboard position in this relationship.

Design/methodology/approach –This paper examines 922 small and medium-sizedlisted enterprises

in China from 2010 to 2017 and empirically investigates the inf‌luence of the internal audit executive’s

supervisoryability (IAESA) on the occurrence of corporatefraud.

Findings –The results reveal that theIAESA is signif‌icantly negatively correlated with the occurrenceof

corporate fraud. This suppression effect is more pronounced when the internal audit executive is also the

company’ssupervisor. However, if the internal audit executive is the chairman of the board of supervisors,the

suppression effect no longerexists. This paper therefore conf‌irms that the IAESA curbs corporate fraud via

the improvementof the internal corporate control level.

Research limitations/implications –Because the sample data was limited by the information

disclosure level of the included companies, the sample size was relatively small as compared with those of

other studies.

Practical implications –This study not only expands the research perspective in the f‌ield of internal

audit functionsbut also provides a decision-making referencefor the prevention of corporate fraud.

Social implications –This paperextends an approach that might be able to curb corporate fraud.

The authors would like to thank all the seminar participants at Central South University for their

valuable comments and discussions. The authors acknowledge the anonymous reviewers and editors

for helpful guidance of the article.

Declaration of Conf‌lict of Interests: The authors declared no potential conf‌licts of interest with

respect to the research, authorship, and/or publication of this article. Any remaining errors are the

authors’own. We also warrant that the work is not an infringement of any existing copyright and

will indemnify the publisher against any breach of such warranty.

Funding: This research work was supported by Major Project for National Natural Science

Foundation of China (No. 71790615), the Youth Project for National Nature Science Foundation of

China (No. 71904208), and the Project of Social Science Fund in Hunan Province of China (No

18YBQ130).

Ability of

internal audit

executives

1

Received13 February 2020

Revised2 July 2020

23July 2020

Accepted24 July 2020

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 1, 2021

pp. 1-26

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-02-2020-0020

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

Originality/value –A comprehensive index was developedusing data envelope analysis to quantify the

supervisory ability of internalaudit executives. Based on this, this research conf‌irmsthat the internal audit

departmentperforms a “f‌irewall function”to prevent corporatefraud.

Keywords Corporate fraud, Internal audit executive, Supervisory ability, Internal control level

Paper type Research paper

1. Introduction

Although China’s capital market system and legal environment have gradually improved

and the internal control level of enterpriseshas been signif‌icantly enhanced, corporate fraud,

such as the illegal rabies vaccine manufacturing of ChangshengBiotechnology Co., Ltd. [1],

the f‌inancial disclosure fraud of GEEYATechnology Co., Ltd. [2] and the illegal stock price

manipulation of GuangzhouAnzhou Investment Management Co., Ltd. [3], remains common

in the f‌inancial market and disrupts the market order. Healthy internal and external

governance environments can either help inhibit these violations or may provide

opportunitiesfor fraud.

Previous studies have conf‌irmed that the regulatoryeffectiveness of external media and

government departments (Yang and Zhao, 2017;Mei, 2018;Xiong et al.,2018;Yin and Li,

2018), analyst tracking (Chenet al.,2016),the level of internal governance (Liang et al.,2004;

Chen et al.,2016;Afriyieet al., 2019), the ownership structure (Fan and Wong, 2002;Lu et al.,

2012;Afriyie et al.,2019) and pay incentive policies (Johnson et al., 2009;Zhang and Zhang,

2017;Wei and Geng, 2018) can provide potential opportunities for violations. As an

important component of the internal corporate governance system, the restraining effect of

the quality of the internal audit function on the quality of corporate f‌inancial reporting has

been widely recognized (Altamuro and Beatty,2010;Wang et al.,2010;Shi et al.,2011;Gros

et al.,2017).

Since the National Audit Off‌iceof the People’s Republic of China issued the promulgation

of the “Chinese Audit Regulations on Internal Audit Work”(January 2018) and the f‌irst

plenary meeting of the Central Audit Committee (May 23, 2018), the status of internal

auditing in corporate governance has increased to an unprecedented height. Internal audit

executives instruct the internal audit department to supervise corporate business

management activities, evaluate internal controls and risks and provide recommendations

for operating. However,f‌inancial fraud is just one important component (Persons,2006;Liou

and Yang, 2008;Khanna et al.,2015;Bai and Koong, 2017;Byun et al.,2019). Current

academic research on corporate fraud governance and market supervision from the

perspective of internal audit executives’supervisory ability (IAESA) remains relatively

limited, and it has not yet been determined whether and how the IAESA affects corporate

fraud.

In this study, small and medium-sized listed enterprises in China in 2010–2017 are

examined, and the relationship between the IAESA and corporate fraud is empirically

tested. To determine the importanceof the organizational status of internal audit executives,

focus is also placed on the suppression effect associated with the internal audit executive

holding a supervisory board position.The contributions of this study are threefold:

(1) A comprehensive index is developed using data envelope analysis (DEA) to

quantify the supervisory ability of internal audit executives and to avoid the

disadvantages of other measurement methods that only focus on a single index

(Lennox, 2005;Dal Mas and Barac, 2018;Roussy and Rodrigue, 2018).

(2) Small and medium-sized enterprises (SMEs) listed in the Shenzhen Stock

Exchange are investigated, rather than using sample data from Shenzhen-A-Share

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