Internal Audit's Organizational Status and Budget Management: A Double‐Edged Sword Analysis

Utilizing unique data on organizational structure from the prospectuses of Chinese listed firms, this study examines how the status of internal audit shapes corporate budget management. We find that internal audit functions reporting directly to the board (i.e., higher status) are associated with lower budget execution deviations but greater budgetary slack during the budget preparation stage, relative to those reporting to senior management (i.e., lower status). These relationships are more pronounced in firms with higher agency costs and elevated operational uncertainty. We further document that higher internal audit status intensifies the budget ratchet effect, resulting in strategic target achievement without substantial overperformance. Ultimately, while reducing budget execution deviations enhances operational efficiency, the induced budgetary slack also poses a threat to the firm's financial performance. Our findings highlight a critical trade‐off in the design of organizational structure regarding internal audit and offer nuanced implications for budget management.