Fighting Corruption by Means of Effective Internal Audit Function: Evidence from the Ghanaian Public Sector

• Author: Eric Worlanyo Deffor,Kofi Fred Asiedu
• Published date: 01 March 2017
• DOI: http://doi.org/10.1111/ijau.12082
• Date: 01 March 2017

Fighting Corruption by Means of Effective Internal Audit Function: Evidence from

the Ghanaian Public Sector

Kofi Fred Asiedu and Eric Worlanyo Deffor

Ghana Institute of Management and Public Administration (GIMPA)Achimota, Accra, Ghana

Using structural equation modelling (SEM) we analysed the link between corruption and effective internal audit

function (EIAF) in Ghana through a survey of directors and managers of selected public sector organizations. A

decade after the promulgation of the Internal Audit Agency Act (IAAA), 2003 (Act 658) as an instrument to fight

administrative corruption in Ghana, there is little empirical evidence to show its impact on corruption, though

anecdotal evidence suggests it has played a critical role in maintaining financial discipline and public sector

accountability and transparency. We established that full implementation of Act 658, size of the internal audit

department and independence of the audit department significantly affect the effectiveness of the internal audit

function which negatively impact on corruption. We conclude that strict adherence to and the implementation of

regulations and lawsas well as independence of the internal audit function will help fight administrative corruption

in Ghana.

Key words: Corruption, Ghana, internal audit, structural equation modelling, public sector

1. INTRODUCTION

A complex socio-economic phenomenon that is difficult to

quantify but has drawn much attention in recent years is

corruption. Corruption is often defined as the abuse or

misuse of public office for private gains (World Bank,

1997, 2004). Other authors have expanded this

conventional definition to include any form of dishonest

or unethical conduct by a person entrustedwith a position

of authority, often to acquire personal benefit (see

Kaufmann & Vicente, 2005; Svensson, 2005). According to

the literature,corruption harms the economicdevelopment

and social stability of nations since it is rooted in the

existenceof privileges and incompletemarket mechanisms.

It is bad for development because it leads governments to

intervene where they need not , thus undermining their

ability to enact and implement policies in areas in which

its intervention is clearly needed: environmental

regulation, health and safety regulation, social safety nets,

macroeconomic stabilization and contract enforcement

(World Bank, 2005a; Liu & Lin, 2012). Corruption is seen

as a primary impediment to growth (Kaufmann & Kraay,

2002), with serious consequences for the economies of

developing countries (Hamilton & Hudson, 2014). While

the phenomenon of corruption is multifacetedand difficult

to measure, and can be encountered in all sectors of an

economy (see,e.g., World Bank,1997, 2005a, 2013; Campos

& Syquia, 2005; Senior, 2006; Znoj, 2009), two perspectives

emerge in the current financial literature and official

pronouncements: bribery and extortion.

1

Bribery entails

malfeasance, fraud and embezzlement by a public official

(Myint, 2000; Enu-Kwesi, 2014), whereas extortion refers

to the use of publicoffice or the use of officialposition, rank

or status by an office holderto extort money or favours for

the individualˈs own personal benefit(see Kaufmann, 2005;

World Bank, 2005a; Heyneman, Anderson & Nuraliyeva,

2008; Enu-Kwesi, 2014).

Other writers challenge the conventional definition of

corruptionby making a distinctionbetween legal and illegal

forms of corruption (see Campante & Ferreira, 2004;

Kaufmann & Vicente, 2005). They discuss legal corruption

to involve collusion between parties both from the public

and private sectors, working together for a common goal

such as legal lobbyingby the private sector in exchange for

passage of particular legislation or allocation of

procurement contracts that make use of publicly invested

power at the expense of broaderpublic welfare (Campante

& Ferreira, 2004; Kaufmann & Vicente, 2005). Illegal

corruption, according to the authors, focuses on bribery

or other illegal forms of activities as abuse of public

office for private gains. Illegal corruption is therefore a

symptom of system and institutional failure,

contributing to misallocation of resources, poverty,

inequality, fiscal indiscipline, and erosion of the trust of

the state (see Johnson, Kaufmann & Shleifer, 1997;

Campos, Lien & Pradhan, 1999; Campante & Ferreira,

2004; World Bank, 2005a).

In sub-Saharan Africa,corruption has been substantially

documented in the financial literatureas one of the drivers

inhibiting development and fuelling poverty (see, e.g.,

World Bank, 1997, 2005a; Van Gansberghe, 2005; Znoj,

2009; Hamilton, 2013; Hamilton & Hudson, 2014; Pring,

2015). One important aspect of corruption in sub-Saharan

Africa is administrative corruption (Campos & Syquia,

2005; Hamilton & Hudson, 2014). The literature defines

administrative corruption as ‘mis-implementation of a

law or a regulation to accommodate bribes or extract

money’(Campos & Syquia, 2005, p. 15). According to the

authors, administrative corruption ranges from ‘petty

bribes to government officials overlooking the violation of

the law all the way to grand-scale corruption in the

awarding of contracts for huge infrastructure projects’.

The consequence of this is that it creates distortions in

government programmes and retards investment, growth

and poverty reduction (see World Bank, 1997, 2005a,

2013, 2014; Kaufmann 2003, 2005; Campos & Syquia,

2005; Pring, 2015).

In Ghana, corruption is reported to have contributed to

the erosion of trust in various state institutions, which in

turn has weakened the stateˈs ability to fight other mal-

administration in the economy (Fosu & Aryeetey, 2008).

According to the authors, it is unsurprising to note that

corruptionprovided rent-seeking opportunities for various

officials in government, and indeed Ghana is replete with

Correspondenceto: Kofi Fred Asiedu,Ghana Institute of Managementand

Public Administration (GIMPA) Achimota, Accra, Ghana. Email:

kasiedu@gimpa.ed u.gh

International Journal of Auditing doi: 10.1111/ijau.12082

Int. J. Audit. 21:82–99 (2017)

©2017 John Wiley& Sons Ltd ISSN 1090-6738

cases of corruptionin all regimes, both civilianand military

(Fosu & Aryeetey, 2008). As economic incentives, these

rent-seeking opportunities contributed to the prevalence

of elite politicalinstability in Ghana in the late 1970s (Fosu

& Aryeetey, 2008).To reversethe trend, several reformsand

anti-corruption laws have been put in place. They include

the Public Procurement Act, 2003 (Act 663); the Financial

Administration Act, 2003 (Act 654) as amended; the

Internal AuditAgency Act, 2003 (Act 658); the Anti-Money

Laundering Act, 2008 (Act 749); and the Whistle Blowers

Act, 2006 (Act 720). Taking the Ghanaian institutional

setting into consideration, this paper examines the Internal

Audit Agency Act, 2003(Act 658) as an instrument to fight

administrative fraud and corruption in Ghana. After a

decade of promulgation, there is little empirical evidence

as to its impact on corruption, though anecdotal evidence

suggests that the Act has played a critical role in

maintaining financial discipline and public sector

accountability and transparency (see, e.g., Auditor-

Generalˈs Report, 2011, 2012, 2013, 2014).

Using data froma survey of directors and managersand

staff of selectedpublic organizations in Ghana,we examine

the effects of lawsand regulations, specifically, the Internal

Audit Agency Act, 2003 (Act 658) in fighting

administrative corruption in Ghana. We hypothesize that

full implementation of the Act is negatively related to

administrative corruption. Our hypothesis is built on the

intuition that fighting corruption in an institution is

contingent on effective internal audit function (EIAF). The

more effective the internal audit function, the lower the

level of corruption in various institutions. Institutions are

supposed to help stem corruption, thus the lack of quality

and effective institutions,

2

such as internal audit functions,

is often cited as the cause for these system failures.

To provide implications for theory and practice, we also

examine the factors influencing EIAF in Ghana since, all

things being equal, an EIAF will help unearth loopholes

and system failures, which in turn will help stem

corruption.Thus, we present empirical evidence of thelink

between EIAF and administrative corruption in Ghana.

Three hundred directors, managers and staff of various

institutions participated in this research, and they were

asked to answer various questions relating to the internal

audit function and corruption in the Ghanaian public

sector. As hypothesized, the findings show that EIAF is

negatively related to administrative corruption. We can

conclude that the enactment of Act 658 has helped the

government to tackle administrative corruption in the

public sector. This study contributes to the literature by

first, empirically establishing the link between Internal

Audit Agency, an element of Act 658, and administrative

corruption in the public sector of Ghana. Second, unlike

other studies on corruption which pay critical attention to

external auditorsto detect fraud and corruption, especially

the annual gover nment auditing of metropolit an,

municipal and district assemblies (MMDAs) by staff of

the audit services, this study provides evidence of therole

of internal regulations and law, such as the internal audit

function, in addressing administrative corruption in

institutions.

2. LITERATURE REVIEW

Corruption and internal audit function

There is a growing literatu re on fraud and corruption

and the internal audit fun ction in developed and

developing economies (see Brierley, El-Nafabi &

Gwilliam, 2001; DˈOnza et al., 2015; Halbouni, 2015).Most

researchers argue that internalaudit functions are a value-

adding process which is critical for uncovering and

preventing fraud in institutions (Richards, 2002; Burnaby,

Howe & Muehlmann, 2009; IIA, 2010; Abbott, Parker &

Peter, 2012). Though most researchers (e.g., Thomas &

Clements, 2002; Halbouni, 2015) believe that it is not the

primary objective of internal auditors to oversee fraud

prevention programmes, it is logical that internal auditors

help in the identification of fraud risks in institutions. For

example, in the course of their work, when they discover

certain risk factors for fraudulent financial reporting in

income, questionable bonus plans and restrictive debt

covenants (Church, McMillan & Schneider, 2001), it

behoves internal auditors to report. In an ACFE survey

in 2008, cited in Halbouni (2015), the survey found that

internal auditors were able to initially detect fraudulent

activity in over 19 per cent of fraud cases in their work

(ACFE, 2008). According to ACFE, this 19 per cent

represented a drastic increase compared with the 9 per

cent of fraud cases that were revealed by external auditors

(Halbouni, 2015) in the same work. Accordingto Halbouni

(2015), despite these relatively low percentages, ACFE

(2008, 2010) concluded that internal audit departments

were the most important entities fordetecting and limiting

asset misappropriations and corruption schemes. The IIA

(1210.A2, p. 6) requires internal auditors to have sufficient

knowledge to evaluate not only the risk of fraud but also

the manner in which organizations manage that risk.

Despite this, the standard does not mandate internal

auditors to have the same degree of experience as those

mandated todetect and investigate fraud (Halbouni, 2015).

Most theoretical studies on corruption focus on the

micro-models of the phenomenon by studying individual

acts of corruption, while the empirical papers typically

study corruption at the country level (see Rose-

Ackermann, 1978; Kaufmann & Kraay, 2002; Kaufmann &

Vicente, 2005; Vicente, 2005; de Graaf, 2007). In all these

studies, three necessary conditions are established to point

to the existence of corruption: discretionary power,

economic rents and weak institutions (see Adit, 2003; Liu

& Lin, 2012). According to Liu and Lin (2012), while the

arbitrary nature of power makes rent-seeking possible,

the lack of strong institutions make ‘public officers with

authority fearless’in extracting and creating rent because

they would be difficult to catch and prosecute.

Corruption is said to be a huge problem that concerns

many economies as it distorts production (Mauro, 1998;

Wu & Yao, 2008), causes redistribution of income, and

makes non-beneficiaries worse off, thus increasing the

gap between the rich and thepoor (Chen & Li, 2010). Most

researchers of corruption believe that the phenomenon

distorts the function of government and market

mechanism by making it difficult to build economic order,

ensure economic development, consequently damaging

social stability(Wu & Yao, 2008; Liu & Lin, 2012;Hamilton

& Hudson, 2014;Pring, 2015). Since corruptionresults from

systems failure, strong institutions or institutionalreform is

a strong counter-strategy to combat the phenomenon.

Strong institutions mean making systems and structures

more effective, including human resource capacity

building in these institutions.

Internal audit function, as part of institutional

governance, is an independent, objective assurance and

consulting activity designed to add value and improve an

organizationˈs operations (see Goodwin & Teck, 2001).

Fighting Corruption by Meansof Effective Internal AuditFunction 83

©2017 John Wiley & Sons Ltd Int. J. Audit. 21:82–99 (2017)