A Model of Outsourcing and Audit Risk for Internal Audit Services

Posted: 24 Jun 2002

See all articles by Dennis H. Caplan

Dennis H. Caplan

Oregon State University - Department of Accounting, Finance, and Information Management

Michael Kirschenheiter

College of Business Administration University of Illinois at Chicago

Abstract

Some companies now outsource their internal audit function to public accountants. Internal auditors and accounting firms disagree about the merits of outsourcing. Each type of auditor claims to provide more cost-effective services and appears to claim superior expertise. This paper uses agency theory to examine outsourcing and reconciles the outsourcing debate without resorting to differential auditor expertise. Under the assumptions that public accountants' "deep pockets" provide incentives to outsource and their higher opportunity cost provides a disincentive, we characterize the optimal employment contract with each auditor. We find that public accountants provide higher levels of testing, but possibly for a higher expected fee. This result supports both the internal auditor's claim as the lower cost provider, and the public accountant's claim of higher quality. We also find that incentives to outsource generally increase in various measures of risk, including the risk that a control weakness exists and the size of the loss that can result from an undetected control weakness.

JEL Classification: M49, D82, G34

Suggested Citation

Caplan, Dennis H. and Kirschenheiter, Michael, A Model of Outsourcing and Audit Risk for Internal Audit Services. Contemporary Accounting Research, Vol. 17, No. 3, Fall 2000, pp. 387-428, Available at SSRN: https://ssrn.com/abstract=316520

Dennis H. Caplan

Oregon State University - Department of Accounting, Finance, and Information Management ( email )

Corvallis, OR 97331
United States

Michael Kirschenheiter (Contact Author)

College of Business Administration University of Illinois at Chicago ( email )

601 South Morgan Street
11th Floor
Chicago, IL 60607
United States
312.996-2284 (Phone)
312.996-4520 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
2,567
PlumX Metrics