A Tale of Two Identities on the Optimal Work Location of the Internal Control Agent From a Principals Perspective

Drawing from and contributing to insights in both the auditing and organizational economics literature, this theoretical analysis considers the optimal work setting for the internal control agent from the perspective of the principal. Specifically, it highlights the trade-off in deciding whether to locate this agent close to the fraud-sensitive activities or as separate entity. The crucial assumption of the applied model concerns the incentivizing effect of identity: if placed at the unit, the control agent is assumed to identify himself as a member of the unit and has an incentive to conceal fraud, while if located separately, his identity as an independent controller appears and he is assumed to gain utility from reporting fraud. Due to the “role-dilemma” rooted in the modern internal control profession, balancing these effects carefully is of large significance to the principal. The basic findings indicate that for relatively large expected losses of fraud, locating the internal control agent separately is optimal. However, when taking into consideration the interaction effect of the external auditor with the internal control agent and the potential fraudsters, the case for locating the internal control agent close to the fraud sensitive tasks strengthens.