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Topics: Internal audit, Auditing, Audit Pages: 18 (3780 words) Published: November 17, 2013
Managerial Auditing Journal
Emerald Article: Agency Theory and the Internal Audit
Michael B. Adams

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To cite this document: Michael B. Adams, (1994),"Agency Theory and the Internal Audit", Managerial Auditing Journal, Vol. 9 Iss: 8 pp. 8 - 12
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http://dx.doi.org/10.1108/02686909410071133
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Agency theory can provide for richer and more
meaningful research in the internal audit
discipline.

Agency Theory
and the
Internal Audit
Michael B. Adams

Managerial Auditing Journal, Vol. 9 No. 8, 1994, pp. 8-12
© MCB University Press, 0268-6902

The literature is replete with studies that have used
agency theory to examine the role of the external auditor
in society (for example [1-5]). However, relatively few
researchers have applied agency theory to the internal
auditing function[6]. This article examines how agency
theory can help explain the existence, role and
responsibilities of the internal audit function and also
provide a useful framework for the conduct of further
empirical research. Key research questions which could
be analysed within an agency theory framework are
outlined in Table I.

principals and that this information asymmetry
adversely affects the principals’ ability to monitor
effectively whether their interests are being properly
served by agents. It also assumes that principals and
agents act rationally and that they will use the
contracting process to maximize their wealth. This
means that because agents have self-seeking motives
they are likely to take the opportunity to act against the
interests of the owners of the firm, for example by
partaking in high levels of perquisite consumption (that
is, perks). Scapens[10] refers to this dilemma as the
“moral hazard” problem. Another type of agency problem
which arises is “adverse selection”. This occurs when the principal/owner(s) does not have access to all available
information at the time a decision is made by a manager
and is thus unable to determine whether managers’
actions are in the best interests of the firm. Scapens
argues that a state of efficiency, or “pareto-optimality”, exists in the contracting relationship between principal/
owners and agent/managers when neither party can
enhance their wealth at the expense of the other. To
ensure pareto-optimality in the contracting process, both
principals and agents will incur contracting costs. For
instance, to minimize the risk of shirking[11] by agents,
principals will incur monitoring expenditures, for
example the costs of subjecting financial statements to
external audit scrutiny. Agents, on the other hand,...

Citations: Managerial Auditing Journal, Vol. 9 No. 8, 1994, pp. 8-12
© MCB University Press, 0268-6902
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