Investigating the audit fee structure of local authorities in England and Wales

Abstract

The purpose of this paper is to model and test the audit fee structure of local authorities in England and Wales, with particular interest in fees charged by the Big 4 and other private sector auditors. The Audit Commission, a national public body under Parliament, regulates local government audits in England and Wales. The Audit Commission sets audit standards, appoints the auditors, and establishes a formula to determine standard audit fees. Constrained by the standard audit fees, each local authority and its auditor negotiate the actual audit fees. The majority of audits are conducted by district auditors (public sector employees under the Audit Commission), although about 25% of local authorities are audited by one of six private auditors (including three of the Big 4). Regression results for financial year 2000/01 have high explanatory power and work well to explain fee differences. Model relationships are somewhat different from US counterparts (which is the context of most of the audit economics literature) and type of authority partially explains fee differences. OLS regression results indicate a Big 4 discount for local authority audits. Because of expected self-selection bias, the Heckman procedure is used to analyse the differences between private sector and public sector auditors, which indicates no selection bias for Big 4 firms, although bias is present for private firms as a whole and district auditors in some models. When fees are size-adjusted, results continue to show a Big 4 discount. The Big 4 discount was robust to other follow-up tests.

An Empirical Investigation of Audit Pricing in the Public Sector: The Case of Greek LGOs

“…Finally, location has been suggested to be influential in fee determination by prior studies (Palmrose, ; Johnsen et al., ; and Giroux and Jones, ). That might be related to economies of density (Gonzales and Mehay, ), structural differences between urban and rural municipalities (Giroux and Shields, ), media coverage (Boon et al., ) and additional services usually provided in urban areas (Giroux and Jones, ). In Greece, there are higher income levels in urban areas, which might relate to stronger financial health of the prefectures of Attiki and Thessaloniki (Cohen, ).…”

“…Therefore, size should be associated with audit fees. Prior studies have consistently documented positive association between size and audit fees in the public sector (e.g., Rubin, ; Johnsen et al., ; Deis and Giroux, ; and Giroux and Jones, ). Similar to prior studies (Rubin, ; and Deis and Giroux, ), we use the natural logarithm of municipal population as a proxy for size.…”

“…This is very similar to findings from the private sector probably because US public organizations operate in competitive markets for the supply of audit services and compete with private firms in capital raising (US municipalities issue bonds which are rated; see Ward et al., ). Subsequent research in Australia (Boon et al., ), Canada (Bandyopadhyay and Kao, ), the UK (Clatworthy et al., ; Basioudis and Ellwood, ; Basioudis and Ellwood, ; and Giroux and Jones, ) and Finland and Norway (Johnsen et al., ) tend to provide broadly similar directions although specific variables differ both in operationalization and magnitude, probably due to the different institutional characteristics.…”

“…Pratt and Stice () found financial condition to be the primary consideration in an auditor's assessment of litigation risk and recommendations for the audit plan and fees. We test the municipal financial condition by leverage and profitability (Giroux and Jones, ). We measure leverage by the debt per capita ratio, following Copley et al.…”

“…While there is a growing literature on the association of audit fees with various factors in the private sector, relevant research in the public sector has, to some extent, stagnated. Additional interest is added considering that the audit fee public sector literature has been mainly tested in the context of the US and relatively recently in other Anglo‐Saxon countries (Giroux and Jones, ) and Nordic Countries (Johnsen et al., ).…”