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The Impact of Ethical Leadership, the Internal Audit Function, and Moral Intensity on a Financial Reporting Decision

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Abstract

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.

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Notes

  1. For a review of the ethical reasoning process in an auditing context, see Jones et al. (2003). Examples of research on the ethical reasoning process in a financial reporting context include Carpenter and Reimers (2005), Gillette and Uddin (2005), Graham et al. (2005), and Belski et al. (2008).

  2. In 2010, we mailed instruments to 1,200 individuals identified by the American Institute of Certified Public Accountants (AICPA) as an executive, manager, or staff accountant employed in business or industry. We received replies from 109 individuals and 13 were returned as undeliverable. The resulting response rate of 9.2% (109 responses divided by 1,187 delivered) is consistent with prior studies involving CFO/controller participants (e.g., Graham and Harvey 2001; Gibbins et al. 2007; Sanchez et al. 2007; Agoglia et al. 2011).

  3. While the decision task in most ethics research involves a forced choice between “right” and “wrong,” our decision task—to make [or not make] the journal entry—is specifically designed to be “ethically neutral.” That is, a reasonable business case can be made for either booking the journal entry or not booking the journal entry. Thus, the term “questionable journal entry” is not meant to suggest “right” or “wrong” but rather refers to uncertainty in the decision.

  4. McMahan and Harvey (2006) dropped the sixth moral intensity characteristic from their analysis when validating their perceived moral intensity scale.

  5. Removing the six participants who failed the manipulation check from the analysis does not change any of the inferences drawn.

  6. The two questions are as follows. First, participants reported their agreement with the statement “most financial managers will view the request by the controller to book a $3 million entry as appropriate given the current financial projections and the controller’s concern for unbilled expenses not included in the year-end financial statements” on a seven-point scale (1 = “very strongly disagree” and 7 = “very strongly agree”). Second, participants reported their assessment of whether the controller’s request to book a $3 million entry is unethical on a seven-point scale (1 = “very strongly disagree” and 7 = “very strongly agree”).

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Authors and Affiliations

  1. School of Business Administration, University of Vermont, Burlington, VT, 05405, USA

    Barbara Arel & Cathy A. Beaudoin

  2. Schools of Business, Wake Forest University, Winston Salem, NC, 27109, USA

    Anna M. Cianci

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  1. Barbara Arel
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  2. Cathy A. Beaudoin
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  3. Anna M. Cianci
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Correspondence to Anna M. Cianci.

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Table 4 Measures of perceived moral intensity
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Arel, B., Beaudoin, C.A. & Cianci, A.M. The Impact of Ethical Leadership, the Internal Audit Function, and Moral Intensity on a Financial Reporting Decision. J Bus Ethics 109, 351–366 (2012). https://doi.org/10.1007/s10551-011-1133-1

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