Internal Audit Quality and Value-Based Strategic Financial Performance: The Mediating Role of Earnings Quality in an Emerging Market
This study utilizes panel data from the Amman Stock Exchange (2017–2023) to demonstrate that internal audit quality significantly enhances value-based strategic financial performance, partly through the mediating role of earnings quality, thereby positioning internal audit as a critical governance capability in emerging markets.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
In the world of business, a company can look successful on paper while quietly losing its way. Imagine a factory that reports high profits because it is cutting corners on safety or delaying necessary repairs. The numbers look good, but the long-term value for the owners is eroding. This disconnect between what the books say and what the business is actually worth is a persistent problem. To solve it, companies rely on two main tools: internal auditors, who act as the company's own inspectors to ensure rules are followed and risks are managed, and financial reports, which tell the story of the company's performance to the outside world. For decades, researchers have wondered if having a strong, high-quality internal inspection team actually helps a company create real, lasting value for its shareholders, or if it is just a bureaucratic formality. Furthermore, they have asked whether the quality of the financial story being told—the accuracy and honesty of the earnings reported—serves as the bridge that turns good internal checks into better business results.
A new study set out to answer these questions by looking at companies in Jordan, specifically those listed on the Amman Stock Exchange. The researchers focused on industrial and service firms over a seven-year period, from 2017 to 2023. Because these companies do not publicly release detailed reports about their internal audit teams—such as how many staff they have or how independent they are—the researchers had to use a clever workaround. Instead of looking at the auditors directly, they looked at the results of the audit process. They measured the quality of the internal audit by seeing how closely a company's actual financial reports matched what was expected based on its situation. If the reports were clean and matched expectations, it suggested a strong internal control environment. They then compared this measure against two different ways of judging success. The first was a standard accounting profit, but the researchers were more interested in a value-based measure called Shareholder Value Added, which calculates how much wealth a company actually creates after paying for the cost of the capital it uses. They also looked at a second value measure, Economic Value Added, to double-check their findings.
The study found a clear and positive link between high-quality internal audits and better value-based performance. Companies with stronger internal controls tended to create more value for their owners. The researchers also discovered that these strong internal controls led to higher-quality earnings, meaning the financial numbers reported were more reliable and less likely to be manipulated. Crucially, the study showed that these high-quality earnings, in turn, were associated with better value creation. This suggests a chain of events: strong internal auditing improves the honesty of the financial reports, and this honesty helps the company make better decisions that lead to real value. However, the researchers were careful to note that this chain is only part of the story. When they added the earnings quality into their analysis, the direct link between internal auditing and value creation became slightly weaker, but it did not disappear. This indicates that while better reporting explains some of the benefit, the internal audit team also helps the company in other, direct ways that do not show up immediately in the financial reports.
The findings held up even when the researchers tested the data with different methods and looked at specific groups of companies, such as those in the service sector versus the industrial sector, or those growing quickly versus those growing slowly. The positive effect of internal audit quality remained consistent across these different groups. However, the researchers also found that the path through earnings quality was less stable when they used a more complex statistical method designed to account for changes over time. This suggests that the direct influence of good governance on value creation is a stronger and more reliable force than the indirect influence that works through the quality of financial reporting. The study concludes that internal auditing is not just a box-checking exercise for compliance. It is a vital part of the company's governance structure that helps protect and grow shareholder value. While the quality of financial reports is an important way this value is communicated and realized, the most significant impact comes from the internal audit function itself acting as a robust system of oversight. For the boards and committees that oversee these companies, the message is clear: investing in high-quality internal auditing is an investment in the company's ability to create genuine, sustainable value.
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