Does internal audit function outsourcing policy matter for environmental, social and governance performance score? Evidence from Bursa Malaysia

Abstract

Purpose Anecdotal evidence indicates the internal audit function may be crucial in supporting the implementation of ESG practices and reporting. However, thus far, no study has been empirically conducted to check how and why internal audit function might affect ESG performance. This study aims to address this gap by examining whether the internal audit budget is positively related to the ESG performance of Malaysian listed firms. It also explores whether the sourcing arrangement of the internal audit function can moderate the internal audit budget – ESG nexus. Design/methodology/approach The secondary data for the paper is extracted from two main sources, namely, the Thomson Reuters Eikon database and firms’ annual reports that were downloaded from the Bursa Malaysia website. The final sample consists of public firms listed on Bursa Malaysia over the period 2010 to 2019. Multivariate tests are used to examine the linkage between the variables. Findings The results show that the relationship between the annual internal audit budget and ESG performance is contingent on the sourcing arrangement of the internal audit function. Specifically, the results show that the annual internal audit budget has a positive impact on ESG performance for firms with an in-house internal audit function but not for firms outsourcing an internal audit function to external providers. Overall, the results suggest that the annual internal audit budget promotes ESG performance for firms performing their internal audit activities internally. Practical implications The findings of this paper provide a strong motivation for authorities in Malaysia to develop new policies and rules aiming at ensuring that internal audit departments are adequately resourced to function effectively, thereby promoting corporate ESG performance. Moreover, the findings may be useful in informing the board of directors and other policymakers that establishing an in-house internal audit department assists in advancing corporate sustainability performance. Social implications The findings of this paper suggest that investors, creditors and other stakeholders should link ESG reporting with the attributes of the internal audit function and outsourcing arrangement when evaluating firm performance. The total annual costs allocated to the internal audit function coupled with the outsourcing arrangement by an external provider should be considered for the overall assessment of the ESG performance and provide additional warranty towards corporate goals’ achievement and sustainability for the society. Originality/value This study extends previous studies on the determinants of ESG performance by focusing on two crucial aspects of the internal audit function: the annual budget and the outsourcing arrangement, a hitherto largely unexplored mechanism by the existing literature.