Emerging academic research suggests companies may be better off having one audit firm assist with both the internal and external audit, punching holes in the Sarbanes-Oxley tenet that external auditors aren’t adequately independent if they assist with internal audits.

Three accounting professors looked at the outsourcing of the internal audit function and the risk of misleading or fraudulent financial reporting. The professors wondered if companies that outsourced their internal audit function to their external auditor before Sarbanes-Oxley prohibited such ties had a higher risk of misleading or fraudulent financial reporting. Their preliminary findings suggest the Sarbanes-Oxley assumptions may have been wrong.

“We looked at accounting risk as an indicator of future problems, like restatement or enforcement actions,” said Douglas Prawitt, accounting professor at Brigham Young University. “We found the accounting risk is lower for companies that outsource internal audit to their external auditor. If the external auditor does both the external and the internal audit, the accounting risk is actually lower.”

Prawitt said there are two competing factors at play. On the one hand, Sarbanes-Oxley reasoned that the external auditor is too economically bonded to the client company if it also performs internal audit work, likely skewing the external auditor’s judgment or ability to be skeptical.

“The flip side of that coin is the knowledge gain,” said Prawitt. “When you do more for the client, you learn more about the client, so you possibly do a better job of both. The explanation we offer is if you do both the external and the internal audit, you’re a better auditor all around, so the financial statements come out with less accounting risk.”

That doesn’t mean, however, that the researchers would advocate for policy change, said David Wood, accounting professor at Brigham Young University and co-author of the study. “Within the current regime, it increases the importance of communication between the different governance players,” he said. “There needs to be more working together to achieve good governance.”

Nathan Sharp, another co-author and a professor at Texas A&M University, said Sarbanes-Oxley’s prohibition of a link between internal and external audit likely still serves an important purpose in investor confidence. “Lawmakers are dealing with a problem with the public’s perception of auditor independence,” he said. “Even if the data go in an opposite direction, they’re not only worried about independence in fact, but they’re also worried about independence in appearance.”

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