A Rotational Model for Internal Auditors: Academic Findings on Its Costs and Benefits

By Hansen, James; Starliper, Matthew et al. | The CPA Journal, October 2013 | Go to article overview

A Rotational Model for Internal Auditors: Academic Findings on Its Costs and Benefits


Hansen, James, Starliper, Matthew, Wood, Daid A., The CPA Journal


Many companies rely on high-quality internal audit fonctions to support important business activities within the organization. Internal audit can play a valuable role in improving many aspects of an organization, but for businesses that want to maximize the effectiveness of their internal auditors, there exists little guidance based on rigorous research methods.

A recent survey found that 64% of respondents from Fortune 500 companies and more than 30% of all companies surveyed actively apply the rotational staffing model in their internal audit fonctions ("Knowledge Alert: Recent Impacts on the Staffing and Sourcing of North American Internal Audit Activities," Institute of Internal Auditors [HA], 2009). In the rotational staffing model, new hires or experienced staff members are brought into the internal audit fonction for a short time (typically two to three years) to prepare them for future managerial positions outside of internal auditing. The rotational model can be applied to the chief audit executive (CAE) position, to internal audit staff positions, or to both simultaneously.

While the perceived costs and benefits of using the rotational staffing model have been debated within the internal auditing community, little research exists to inform this important debate. Four recent studies can help business professionals understand the positive and negative impacts of the rotational model.

Cost: Lower Monitoring Effectiveness

"Using the Internal Audit Function as a Management Training Ground: Is the Monitoring Effectiveness of Internal Auditors Compromised?" studied the relationship between the use of the rotational staffing model and the monitoring ability of the internal audit function, as measured by two organizational factors: 1) the risk that the financial results presented in the financial statements contained misleading or fraudulent representations, and 2) executive compensation (Margaret Christ, Adi Masli, Nathan Sharp, and David Wood, working paper, Brigham Young University, 2013). The authors examined 157 publicly traded companies over six years, using data collected from the IIA's GAIN survey (https:// na.theiia.org/services/gain/pages/gainbenchmarking.aspx).

The authors found that internal audit functions that use the rotational model have lower internal audit quality, an aggregate score combining dimensions of internal audit experience, certifications, training, size, and objectivity. These companies also tend to have higher turnover and outsource more of the internal audit fonction than companies with career internal audit staffing models. The authors also found that the risk of the company engaging in inappropriate or aggressive financial reporting is greater for organizations that use the rotational model than those that do not. Lower internal audit quality and higher risk of inappropriate or aggressive financial reporting suggest that internal audit functions using the rotational model are, on average, less effective than those with career internal auditors. This effect is exacerbated when the CAE position is rotational.

"Excessive" executive compensation, the second factor this research examined, can result in wasted resources, poor company performance, and negative press coverage. As stipulated by the IIA, the internal audit function can help mitigate these negative risks by effectively reviewing executive compensation programs. According to this study, internal audit functions that use rotational staffing models are associated with executives who earn significantly higher pay once other determinants of executive pay (e.g., size of organization, performance) are controlled for. That is, if companies use a rotational staffing model for the internal audit function, executives are more likely to be paid more.

Overall, this study presents evidence that, on average, using a rotational staffing model results in two negative effects on organizations: 1) lower financial reporting quality and 2) higher executive compensation. …

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