Cathy Beaudoin

The Impact of Ethical Leadership and the Internal Audit Function on Financial Reporting Decisions

Two elements of corporate governance — the strength of ethical executive leadership and the internal audit function (IAF hereafter) — provide guidance to accounting managers making decisions involving uncertainty. We examine the joint effect of these two factors, manipulated at two levels (strong, weak), in an experiment in which accounting professionals decide whether to book a questionable journal entry (i.e., a journal entry for which a reasonable business case can be made but there is no supporting documentation). We find that ethical leadership and the IAF interact to determine the likelihood that accountants book the entry. Specifically, accountants are less likely to book a questionable journal entry when there is a weak ethical leader and a strong IAF compared to all other conditions. In addition, we find that accountants question the appropriateness and ethicalness of the request to book an undocumented journal entry more in the weak ethical leader and strong IAF condition than in the other conditions. These results suggest that the IAF has a different impact on financial reporting decisions depending on the ethicalness of executive leadership and that a strong IAF may cause accountants to question the appropriateness and ethicalness of an undocumented journal entry when combined with weak ethical leadership. We also find that the interactive effect of ethical leadership and the IAF on an accountant’s decision is fully mediated by his/her perception of the moral intensity of the issue. Thus, accountants, who perceive greater moral intensity associated with booking the entry, are less willing to do so.

Control Systems and Incentives as Moderators of the Positive Association between Perceived Environmental Uncertainty and Willingness to Recommend Strategic Change

To remain competitive, organizations must change in response to demands in the dynamic environments in which they operate; yet oftentimes they do not change, perhaps due to an inability to first recognize, and then act on, the need for change. To combat this reluctance, organizational factors such as control systems and incentives may be effective since they are often used to direct managerial attention and thereby influence firm strategy (e.g., Simons 1990, 1995; Garg et al. 2003; Kober et al. 2007; Peterson and Luthans 2006). Indeed, prior research has found that control systems influence managers’ information search as well as firm-level strategic choice (e.g., Simons 1990, 1995) and incentives are closely tied to managers’ motivation to act (e.g., Bruggen and Moers 2007; Peterson and Luthans 2006). To further investigate this issue, we examine whether one individual-level variable – perceived environmental uncertainty (hereafter, “PEU”) – and two firm-level variables – control systems and incentives – are effective in overcoming managers’ insufficient motivation and/or their inability to recognize that change is needed, thereby increasing their willingness to recommend strategic change (hereafter, “WTRC”). Consistent with expectations, we find that the positive association between PEU and willingness to recommend strategic change is diminished by all combinations of control systems and incentives (except for an interactive system–social recognition incentive combination). Regarding this result, neither interactive systems nor social recognition incentives seem to provide a point of focus for managers to interpret strategic threats, thereby lowering the likelihood that managers will recommend strategic change. Thus, the positive association between PEU and WTRC remains intact. However, for low PEU managers, both diagnostic systems and financial incentives seem to make low PEU managers behave more like high PEU managers by focusing attention on performance metrics, thereby creating a strategic decision-making framework that increases the likelihood of recommending strategic change. Overall, these results suggest that the positive association between PEU and managers’ willingness to recommend strategic change can be enhanced, or muted, by control systems and incentives.