State Audit Budgets and Market Assessments of Credit Risk

Posted: 19 Jul 2014

See all articles by Barry R. Marks

Barry R. Marks

University of Houston, Clear Lake - School of Business and Public Administration

K. K. Raman

The University of Texas at San Antonio

Date Written: Winter 1986

Abstract

While financial statement auditing dominates the market for corporate auditing, internal controls and operational auditing appear to be emphasized in governmental markets. The size of the governmental audit budget (beyond the minimum level prescribed by generally accepted auditing standards) is ultimately a cost/benefit decision, with lower borrowing costs being one of several potential benefits. In testing for empirical regularities between auditing quantity and investor decisions, we found the size of the audit budget to be indeed associated with borrowing costs, but the direction of the relationship was anomalous. The anomalous positive sign for the audit budget variable could be due to self-selection bias. Self-selection bias is a confounding effect that has come up repeatedly to muddy the interpretation of empirical findings in prior (corporate) market based research on discretionary accounting variables. The supply of (discretionary) internal and operational audits may be driven by operational considerations (e.g., internal control weaknesses), which cannot be directly observed by outsiders. The bond markets may be interpreting the size of the audit budget as a signal about underlying economic characteristics that make the state a more risky investment. Alternatively, larger state audit budgets may signal less use of private sector auditors and be interpreted as less useful to investors (though, possibly more useful to governmental concerns focusing on compliance issues). Despite the inclusion of CPAs' audit fees in state budgets, the signal "inferred" for the state's municipalities may have a carryover effect onto state issues.

Keywords: State audit budgets, Credit risk, market assessments

JEL Classification: M41

Suggested Citation

Marks, Barry R. and Raman, K. K., State Audit Budgets and Market Assessments of Credit Risk (Winter 1986). Journal of Accounting and Public Policy, Vol. 5, No. 4, 1986. Available at SSRN: https://ssrn.com/abstract=2467634

Barry R. Marks

University of Houston, Clear Lake - School of Business and Public Administration ( email )

Houston, TX 77058
United States

K. K. Raman (Contact Author)

The University of Texas at San Antonio ( email )

One UTSA Circle
San Antonio, TX 78249
United States
210-458-8749 (Phone)

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