The Introduction of State Regulation and Auditor Retendering in School Districts: Local Audit Market Structure, Audit Pricing, and Internal Controls Reporting

Abstract

Scandals discovered in New York school districts resulted in two legislative acts designed to improve internal control systems and independent audit quality within the State's school district audit market. The legislation requires that audits be awarded through a formal requisitioning process (RFP), including optional rotation, every five years. The Office of the New York State Comptroller auditors also began performing internal control inspections at school districts and performing audit quality inspections of independent auditors. Post-regulation, the audit market became more concentrated, with greater usage of specialist audit firms and fewer small firms. Audit fees and audit report lag increased substantially and specialist auditors began earning a fee premium. We also find a significant increase in internal control exceptions reported by New York school districts and variation in the reporting of control deficiencies by auditor type.