Compensation and objectivity among internal auditors (Loukas Balafoutas, Simon Czermak, Marc Eulerich and Helena Fornwagner)

Loukas Balafoutas and Helena Fornwagner 

This study examines the behavior of internal auditors under different incentive schemes. It has been suggested in the literature that incentive-pay compensation for auditors has the potential to lead to dishonest behavior on their part, for instance when their payoff depends on the performance of the unit that they are auditing. We conduct a lab-in-the-field experiment with internal auditors during two large conferences in Germany and evaluate their performance and objectivity, measured as the extent to which they truthfully report the performance of other participants a real-effort task. We vary incentives in the experiment from individual (piece rate) to competitive (tournament against other auditors) and collective (based on performance within a team). In line with our hypotheses, we find that incentive-based compensation increases dishonest behavior among internal auditors: competitive incentives lead to under-reporting of other participants' performance and to a decrease in performance, while collective incentives lead to over-reporting of performance.