The Effect of Changes in Internal Control Systems on Audit Risk

Abstract

Internal control weaknesses influence audit fees and audit risk, making their remediation a crucial aspect of corporate governance. While prior research focuses on auditors, this study examines the corporate perspective, analyzing how the remediation of internal control weaknesses affects audit fees and audit risk. Using a dataset of 450 observations, the audit fee model shows a significant negative association between audit fees and the remediation of internal control weaknesses, indicating that audit fees decrease as the company remediates its internal control weaknesses. The restatement model shows no significant relationship between abnormal audit fees and the probability of restatements, suggesting that changes in audit fees due to changes in internal control systems have no impact on audit risk. However, the remediation of internal control weaknesses is significantly negatively associated with the probability of restatements, meaning that firms that remediate their internal control weaknesses experience a lower audit risk and higher audit quality. These findings highlight the economic significance of internal control quality and its implications for firms, regulators, and auditors in mitigating audit risk.

Keywords: audit fee model; audit quality; audit risk model; internal control weaknesses; restatement model