A PUBLIC SECTOR ANALYSIS OF AUDIT PRICING, AUDIT COMPLIANCE, AND AUDIT CONTRACT TYPE

The objective of this study is to extend the audit economics research by (1) examining potential determinants (audit report compliance, auditor expertise, auditor tenure, and audit contract type) of audit fees, and (2) examining potential determinants (prior year audit fee, client risk, auditor expertise, and auditor tenure) of the probability of negotiating a particular contract type (fixed fee or cost-reimbursement). Two separate analyses were conducted using North Carolina county and city data. First, an OLS regression model was used to examine the potential determinants of audit fees. Second, a logit regression model was used to examine factors that may influence the probability of negotiating a particular contract type. The fee analysis found that audit fees negotiated under fixed fee contracts are lower than fees negotiated for cost-reimbursement contracts. This finding is consistent with explanations in the Palmrose (1989) private sector study that fixed fee contracts may provide greater efficiency incentives for the auditor to minimize the total cost of the audit. In addition, findings from the audit fee analysis suggest that auditors with both greater expertise in the governmental sector and longer tenure on a particular audit command a fee premium. Further investigation of the factors associated with fixed fee or cost-reimbursement contracts suggests that the probability of negotiating a fixed fee contract is increased for (1) auditors who have greater expertise in the governmental sector, and (2) clients who paid lower prior year audit fees and/or displayed higher overall risk.; These findings have implications for audit policy decisions. In fact, North Carolina county and city governments may be able to reduce the cost of their independent audits by using fixed fee audit contracts. Since auditors with greater expertise are associated with the increased probability of negotiating a fixed fee contract, there should be an added incentive to employ auditors with proven expertise. Also, it may be in the public's interest for governments to avoid paying higher audit fees for client specific quasi-rents by periodically changing auditors through a formal competitive bidding process.