Resolution of the Internal Audit-Based Role Conflicts in Risk Management: Evidence from Signaling Game Analysis

This study analyzes the inherent role conflicts of internal audit in risk management and clarifies the conditions for the resolution of them using a signaling game model. In the model, we determined five perfect Bayesian Nash equilibriums. The analysis emphasizes the compatibility between the assurance or consulting roles of internal audit and service demand of management. Two equilibriums come to the fore in this respect, and both of them set a game-theoretic ground for the theoretical arguments. Firstly in the face of uncertainty about the risk maturity level of the organization, internal auditors should prefer assurance service in enterprise-wide risk management. The analysis of the equilibriums supports the idea that the assurance role being the core task of internal audit continues to be the key component of the audit profession. Secondly, in “risk-mature” organizations, it is possible to create more value by focusing on the assurance role, whereas for the early stages of risk management, focusing on the consulting role enables one to add more value. The predictions of equilibrium results are in line with this theoretical argument. Furthermore, the equilibrium results imply that the compatibility predicted by the equilibriums features the necessity of proper dialogue mechanisms and especially an effective negotiation process between the internal audit and management. The dialogue and negotiation competency of the relevant parties will enable them to find mutually optimal strategies in accordance with the risk maturity level and ultimately to contribute to the resolution of inherent role conflicts.