Regulatory Audits determine whether or not an organization's practices live up to government standards. The results of a Regulatory Audit can impact business operations and have a negative impact on brand image.
For example, a safety compliance audit may check if an organization follows OSHA's health and safety guidelines. Failure to do so can result in hefty penalties.
Deficiencies
While audits are a vital component of risk management, they are not foolproof. When deficiencies are discovered, they can damage the credibility of financial statements, erode investor confidence, and result in penalties from regulators.
Deficiency assessments are conducted using a combination of techniques, including document review, interviews with personnel, and testing procedures. When multiple deficiencies Compliance Training are identified an aggregation assessment is performed to determine whether they jeopardize the objectives of a SOC 1 report or the criteria of a SOC 2.
An example of a control deficiency is when a company's sole accountant quits, leaving an inexperienced accounting clerk to manage bank reconciliations (a type of internal control). This deficiency may be considered significant, as it could lead to inaccurate financial statements and serious business damage. Moreover, failure to identify and remediate deficient controls can be catastrophic, as the Enron and Mattel cases demonstrate. This can cause major loss in consumer and investor confidence, and even destabilize capital markets.
Penalties
A regulatory audit ensures that a company meets standards set by law, regulating agencies, and professional bodies. These standards can be enforced through a variety of mechanisms, including fines, suspension, and termination. This type of audit has been around for a long time, with regulations dating back to standardized weights and measures, but it grew exponentially in the Industrial Age as government, industry, and social welfare groups sought greater accountability.
The problem is that regulation often fails to accomplish its intended goals. Economic theory reveals several reasons for this, including moral hazard: Individuals who believe that others will mitigate their risk-taking may engage in more risky behavior than they otherwise would. This same logic applies to auditors and inspectors. It's important that you understand the risks associated with a regulatory audit so that you can take proactive steps to minimize your business impact. For example, the National Fire Protection Association compliance questions that ask whether the proper DOT signage is posted and if shipment papers are properly completed could have serious implications if not addressed adequately.
Reputation
Regulatory compliance audits ensure that an organization's internal and external policies and procedures are compliant with industry standards, laws, regulations, and rules. These audits are conducted by an independent auditor and can be a requirement for receiving government funding or a contract with a government department. These audits can be both costly and harmful to the company's reputation. Moreover, they can also result in high attrition rates, especially from board level exits.
Our study contributes to the archival research demonstrating that negative inspection findings convey incremental information in the market, which affects investors' valuations of the audit firm's client (Dee et al., 2011; Offermanns & Peek, 2020). We manipulate the regulatory enforcement style and audit firm response to examine how these cues interact in the information environment to impact investors' willingness to invest. We find that if the audit firm responds with defensive actions, consistent with the diminishment posture of SCCT, investors perceive greater responsibility for the audit firm and are less likely to invest.
Business Impact
It's important to remember that a regulatory audit is more than a checkbox on your compliance program. These types of audits can have reputation, business, and brand implications. They also can create perceptions of a systemic problem that needs to be corrected by regulators. Depending on the outcome of the audit, the company can be fined or even face closure.
Regardless of whether the audit is critical or supportive, companies should respond in a way that mitigates the negative impacts on their business. This type of response aligns with the diminishment posture introduced in Situational Crisis Communication Theory (SCCT). By reacting defensively, organizations attempt to decrease stakeholders' perceived severity of the negative event.
Previous research shows that regulators' enforcement styles convey different information to investors when they release inspection findings (e.g., Gipper et al., 2020). Our study aims to explore how the combination of regulatory enforcement style and audit firm response influences investors' perceptions of audit quality and investment decisions.
