EV and Eff of Auditing Public Schools

The Economic Value of Auditing and Its Effectiveness in Public School Operations*
YOSHIE SAITO, Eastern Illinois University CHRISTOPHER S. MCINTOSH, University of Idaho 1. Introduction Numerous studies have documented the important role auditing plays in the public sector (Baber 1983, 1994; Bendor 1990; Deis and Giroux 1994). Because governance mechanisms are less intense than in private sector capital markets, auditors provide a control function in monitoring public sector entities. However, it is unclear whether auditing ultimately produces economic value for stakeholders in this setting. In theory, if the costs of auditing exceed the benets, there is no justication to allocate public resources to auditing activities. This is especially true in the public sector where resources must be allocated among different governmental operations, all of which compete for a share of the budget. This paper sheds light on this issue and analyzes the economic impact of the auditing of public school operations from the stakeholders point of view. We dene stakeholders as educational and political interest groups and taxpayers. The objective of the study is to examine whether auditing provides a monitoring function to enhance optimal resource allocation and whether the layers of complexity for an audit create a roadblock that can hinder its effectiveness. Our results indicate that auditing improves the efcient use of public resources by reducing nonproductive use of tax dollars as illustrated in Figure 1. However, we also nd that the complex new regulation reduces auditing effectiveness. Governmental auditing provides two types of services that enhance scal monitoring of public education. The rst is nancial auditing that provides attestation of the veracity of nancial statements. The second is performance auditing that assesses the quality of internal controls. Because auditors assess
* Accepted by Raf Indjejikian. The authors would like to thank C. A. Knox Lovell, Shawna Grosskopf, Tim Park, John Penson, William Baber, Ehsan Feroz, Teresa Gordon, Richard A. Lord, William Kinney, and seminar participants at the University of Georgia, Utah State University, and the University of Idaho for constructive comments on earlier drafts of this manuscript. The authors also would like to thank Graham Lynch (at the Georgia Department of Audits and Accounts) who provided us with auditing time data, participants at the 2003 AAA national meeting, and participants in the 2002 North American Productivity Workshop for comments on earlier drafts. Finally, the authors would like to thank the comments received from two anonymous reviewers and the associate editor, Raf Indjejikian. All remaining errors are the sole responsibility of the authors.
Contemporary Accounting Research Vol. 27 No. 2 (Summer 2010) pp. 639667 CAAA doi:10.1111/j.1911-3846.2010.01019.x
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Figure 1
Contemporary Accounting Research

Output distance function and nonproductive use of taxes
y2
Efficient Frontier
ID(w/c, y)
Audit Effect y* yo
IP(w/c)
y1
Notes: yo is school performance without auditing. y* is actual performance. ID(w c, y) is the cost distance function. IP(w c) is the budget constrained production possibilities set. y1 and y2 are educational outputs such as grade 12 reading and mathematics average school districts student test scores.
the reliability of nancial reporting, the attestation by auditors should reduce agency costs between elected ofcials and political interest groups by enhancing the credibility of nancial statements (e.g., Baber and Sen 1984; Baber 1983, 1994). Public ofcials, legislators and citizens need to know whether government funds are handled properly and in compliance with laws and regulations (U.S. General Accounting Ofce [USGAO] 1994a, 2007a,b). We investigate the governance role played by auditing because prior studies have extensively documented the inefcient use of educational resources (Hanushek 1986, 1996; Grosskopf, Hayes, Taylor, and Weber 1997). To assess the impact of elected ofcials incentives to supply auditing and their effectiveness, this study examines the period following the passage of the Quality Basic Education (QBE) Act in the state of Georgia in 1985.1 The QBE Act was intended to ensure that Georgia students receive a
1. The QBE Act was enacted and signed on April 16, 1985. However, there was controversy over how QBE should be implemented. In 1987 and 1990, QBE was revised and the state funding of education was increased, but by 1992 overall funding per student had decreased.
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quality K-12 education. Along with this mission, elected ofcials introduced new state funding schemes to enhance the quality of public education. Thus, QBE funds are directly tied to political promises made by elected public ofcials who need to demonstrate the veracity of their commitments and have a strong incentive to make good on their pledges. An audit does not directly inuence the allocation of school resources. However, according to Georgia State Law (O.C. G.A. 20-2-67 (b)), state auditors have oversight responsibility over local school districts nancial reports and the obligation to assure the proper use of QBE funds, and hence provide a governance mechanism to mitigate inefcient use of resources.2 We dene audit efciency as the ability of auditing to reduce school districts nonproductive use of tax dollars, which can manifest as perquisite consumption by educational ofcials. In Figure 1, we describe how we estimate the effect of auditing on inefcient employment of resources by school districts. Our denition of audit efciency is different from that of Dopuch, Gupta, Simunic, and Stein 2003, because we consider auditing in a competitive budgetary environment and examine the incremental effect of auditing on public resource use. They dene efciency as the optimal utilization of labor resources to produce an audit. Our research contributes to the accounting literature in several ways. First, the results provide compelling evidence that state auditors enhance efciency in the use of school resources. There is a signicant positive relationship between auditing effort and the efciency of school districts operations. Assuming that specic funds do not affect audit efciency, we show that the Georgia State auditing contributes to the reduction of school districts nonproductive use of taxes by approximately $144.9 million (statewide annual average) during the two-year period between the 1995 1996 and 1996 1997 academic years. This result indicates that auditing plays a crucial role in enhancing optimal resource allocation in government operations. Second, this paper shows that the benets of auditing diminish as the complexity of the procedures increase. The distribution of QBE funds is based on complex formulae, which increases the demand for auditing. Our result suggests that the budget allocation for auditing is insufcient. The complexity associated with the implementation of QBE funding results in inefciencies totaling $180 million. Such inefciency can be interpreted as an increase in costs of auditing as regulators impose an extra burden on the auditors. The results also show that the auditing of federal funds, where the rules have been more stable and long standing, is more effective, suggesting that experience helps to improve the effectiveness of auditing. Third, in terms of a policy evaluation, our analysis supports the notion that auditing is important to establish governance mechanisms and suggests
2. Because auditors are outside of the purview but affect the outcome of school districts production functions, this provides an ideal setting, as described by Battese and Coelli 1995, to conduct a second-stage analysis employing the estimated efciency scores.
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that disclosure about auditing costs is vital to adequately evaluate a new policy. The lack of disclosure of auditing costs hinders the ability to conduct a cost-benet analysis of new requirements. The state Department of Education voluntarily discloses student performance based on QBE funds, but it can avoid disclosure that might raise concerns about the implementation costs. This asymmetry in information disclosure may contribute to the shortfall in resources allocated to auditing. Fourth, this paper makes a methodological contribution. The analysis demonstrates the applicability of the econometric method of estimating an efcient frontier to evaluate the contribution of auditing. Prior studies have introduced frontier estimation techniques as a relative performance evaluation in several different settings. The two most widely used methods are Data Envelopment Analysis (DEA) (Banker 1989; Mensah and Li 1993; Dopuch et al. 2003) and Stochastic Frontier Estimation (SFE) (Dopuch and Gupta 1997; Banker, Change, and Cunningham 2003; Dopuch et al. 2003). Here, both approaches are employed to evaluate the economic benets of auditing. We note that our results for both the DEA and stochastic methods are consistent. While Dopuch et. al. (2003) nd these two methods produce different results, we suggest that their nding may be due to the model specications that impose restrictions on cost behavior.3 2. Background, schools, and auditing Governmental accounting differs from that of the private sector in several respects. In this section, we summarize the structure of budgetary allocation, characteristics, and environmental factors that might affect efciency and effectiveness of auditing of public school operations in the state of Georgia. The introduction of quality basic education funds and the structure of the organization In Georgia, the Quality Basic Education (QBE) Act was signed in 1985. The QBE Act provided new funds to local school districts with a stated goal of improving the quality of public education. Because funding must satisfy three conicting goals (equity of opportunity for all children, taxpayer equity, and reduction of political waste)4 QBE funds are based on a
3. In their DEA approach, Dopuch et.al. (2003) use a constant return-to-scale model (their equation 4), which is known to impose a priori restrictions. We use a variable return-toscale model. For SFE, they modify a Cobb-Douglas cost function by including interactions between log of assets and client characteristics. They choose to include clients assets but no other clients operating activities. There is no explanation of a choice of this functional form. We use a translog functional form which imposes fewer a priori restrictions on the outcome of the estimation than other second order polynomial forms. Taxpayer equity means that no taxpayer has to pay a disproportionate share of tax dollars relative to other taxpayers. Equity of educational opportunity means that all students receive the essential educational programs and services needed to develop their potential no matter where they happen to live or what special needs they might have (Harris 1986a).
4.
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complex formula (QBE formula). QBE species funds to be used for specied educational programs, such as handicapped, gifted, and limited-Englishspeaking students.5 These funds are distributed on a per student basis and include the training of educators, equipment, and materials for use in the classroom. In addition, some parts of QBE funds are designated for small size schools or districts to satisfy an equalization policy. Each fund allocation has a specic weight, and hence, extensive data gathering is required to calculate the allocated amounts (FitzGerald 1991). The county board of education is the lowest level government authority exercising oversight responsibility. The board prepares a nancial budget plan for each scal year to control overall activities related to public education in the county.6 In accordance with provisions of the QBE Act, the Georgia Department of Education allocates sufcient funds for local school operations (O.C.G.A. Section 20-2-167). Because all unexpended budget authority lapses at the end of each scal year, school district administrators are often depicted as budget maximizers who exhaust all budgets in order to maintain the current level of funding for the subsequent year (Deis and Giroux 1994). Consistent with this budget maximization behavior, the data indicate that almost all allocated funds are expended within a year. There are three sources of funds for public education: local, state and federal. About 90 percent of state funding in Georgia comes from QBE funds. As shown in Table 1, QBE funds (QBES and QBER) are the largest source of funds, followed by local funds (LOCS and LOCR) and federal funds (FEDS and FEDR), respectively.7 The role of state auditors Auditors responsibilities in the public sector are different from those in the private sector. The basic accounting entity for governmental operations is the fund, which requires separate budget-based accounting and self-balancing (Zimmerman 1977; Ingram 1984). Expenditures denote the use of governmental resources, and nancial statements report nancial position, comparison of revenue and expenditure, and also changes in fund balances. The Government Auditing Standards issued by the Comptroller General of the United States is the primary guideline for the performance
5. These programs include support for handicapped students, gifted students, special instructional assistance, remedial education and limited English-speaking students. For example, the programs for handicapped students are divided into four levels, Mild-resourced, Moderate-resourced, Moderate-self-contained, and Severe-self-contained. Different weights are assigned to each of these in the QBE formula. The board is not included in any other governmental reporting entity as dened by Governmental Accounting Standards Board (GASB) and Financial Reporting Standards. An analysis not presented here for the sake of brevity shows that the current period budget per student is based on the prior period budget from all three regimes, local, federal, and QBE (state).
6. 7.
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TABLE 1 Descriptive statistics for auditing time, funds allocation, and student enrollment (excludes school districts with private auditors) Variables AUDT Year 1996 1997 1998 1994 1995 1996 1994 1995 1996 1994 1995 1996 1994 1995 1996 1994 1995 1996 1994 1995 1996 1994 1995 1996 Mean 509.276 619.428 575.117 $2755.388 $2908.034 $3096.509 $488.118 $537.525 $547.533 $1407.059 $1493.622 $1554.017 5078.77 5228.84 5358.34 0.5495 0.5374 0.5511 0.0962 0.0983 0.0967 0.2719 0.2670 0.2668 Std 239.104 294.853 300.178 $305.700 $310.230 $319.648 $173.846 $172.831 $172.792 $659.185 $688.527 $673.317 7951.59 8263.68 8536.32 0.0923 0.0940 0.1043 0.0338 0.0312 0.0321 0.1050 0.1028 0.0978 Median 464.000 571.000 524.000 $2795.488 $2947.273 $3140.178 $480.448 $523.172 $544.472 $1243.232 $1309.090 $1371.437 3118.00 3123.00 3253.00 0.5656 0.5578 0.5767 0.0950 0.0981 0.0949 0.2436 0.2458 0.2527 Minimum 179.000 201.000 173.000 $847.863 $1037.345 $1230.029 $115.011 $197.376 $173.994 $336.871 $484.750 $391.719 496.00 475.00 494.00 0.1442 0.1756 0.2148 0.0194 0.0296 0.0305 0.0786 0.1068 0.0881 Maximum 1789.000 2173.000 2474.000 $3253.002 $3749.528 $4262.168 $1346.793 $956.204 $981.148 $3884.546 $4072.394 $4015.931 83722.00 87291.00 90311.00 0.6374 0.6582 0.6486 0.2812 0.1689 0.1611 0.7644 0.6582 0.7705
QBES
FEDS
LOCS
TENR
QBER
FEDR
LOCR
Notes: AUDT is auditing time (hours) for the school, data from the academic years from 1996 97 to 1998 99. QBES is the dollar value of QBE funds allocated to school districts per student for the academic years from1994 95 to 1996 97. LOCS is the dollar value of LOCAL funds allocated to school districts per student for the academic years from 1994 95 to 1996 97. FEDS is the dollar value of FEDERAL funds allocated to school districts per student for the academic years from 1994 95 to 1996 97. TENR is the total enrolment for a school district for the academic years from 1994 95 to 1996 97. (The table is continued on the next page.)

TABLE 1 (Continued)
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QBER is the percentage of QBE funds in total budget allocated to a school district, which includes all of state budget. FEDR is the percentage of federal funds in total budget allocated to a school district, which includes all of state budget. LOCR is the percentage of local funds in total budget allocated to a school district, which includes all of state budget. Since QBE is a large proportion of state budget but not all, the summation of above do not add up one.
of government audits. These standards are often referred to as Generally Accepted Auditing Standards (GAAS).8 Under governmental auditing standards, auditors not only provide opinions on nancial statements, but are also required to provide written reports on an entitys internal nancial control systems. OMB Circulars A-128 and A-133 require that government auditors perform tests of compliance with the rules of specic funds, laws, and regulations to determine whether an audited entity has utilized governmental resources according to statutes and specic legislative appropriations (Raman and Wilson 1994; Gauthier 1991; Banker, Cooper, and Potter 1992).9 The Single Auditing Act of 1984 (USGAO 1994b, 1996) promotes uniform entity-wide audit coverage, and thus ensures that nancial information in this sector is a homogeneous audit product (Deis and Giroux 1992; Dopuch et al. 2003; Keating, Fisher, Gordon, and Greenlee 2005).10 Accordingly, accounting rules and regulations are uniformly applied to all school districts in Georgia, 90 percent of which are audited by state auditors. This provides an ideal setting to utilize the second stage approach to examine the economic contribution of auditing to public school operations (Battese and Coelli 1995). Accountability increases demands for information about government programs and services. Accordingly, an auditor examines the design of
8. 9. The full text of the Yellow Book can be found on the USGAOs website, at http:// www.gao.gov/govaud/ybk01.htm (last accessed June 2007). The Governmental Accounting Standards Board (GASB) was established by the Financial Accounting Foundation in 1984. The GASB is the successor of the National Council on Governmental Accounting (NCGA), and its overall goal is to establish standard accounting and reporting procedures for state and local governments. Its mission includes: (a) comparing actual nancial results with legally adopted budgets; (b) assessing the nancial condition and results of operations; (c) assisting in determining compliance with the rules of specic funds, nance-related laws and regulations; (d) assessing the performance of internal control system; and (e) assisting in the evaluation of efciency and effectiveness. Related issues are discussed in the Ofce of Management and Budget (OMB) Circulars A-128 (1984) and A-133 (1996).
10.
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relevant internal control policies and procedures, assesses reportable deciencies, and veries the effectiveness or efciency of off-balance sheet wealth transfers (Baber 1994). These various levels of responsibility make governmental auditing complex. However, at the same time, they provide an opportunity for auditing to play a critical role in enhancing both external and internal monitoring systems in the governmental operations. The Georgia state constitution denes education as a primary responsibility of the state. Georgia Law O.C.G.A. 20-2-67(b) species that local school systems should be in a form to be specied and prescribed by the state auditor. Under this law, the responsibility of the Department of Audits and Accounts includes conducting performance audits on the efciency and effectiveness of state programs (e.g., QBE funds) and activities.11 Auditing fees are not separately charged to local school districts unless a private auditing rm is employed.12 Thus, auditing efforts do not directly affect the allocation of resources. 3. Hypotheses development The state support of public education through QBE funding signicantly increased the amount of nancial resources devoted to public education (Dayton and Matthews 1995). As a result, elected public ofcials reputations are tied to the success of the program. There is a potential penalty to be paid if the goals of QBE are unfullled. Thus, elected public ofcials have an incentive to implement an effective monitoring system if they are interested in enhancing their personal objective functions (e.g., reelection and reputation). The QBE funding systems redistributed tax revenues across the state. These changes in distribution of tax revenues generated risks for elected ofcials because the failure of QBE to improve educational outcomes would damage the reputations of the politicians. Increased calls for improving efciency in the use of school resources arise from the increases in real expenditures accompanied by the decline in performance of American schools (Hanushek 1986, 1996; Grosskopf et al. 1997). Public ofcials, legislators and citizens want to know that government funds are handled in compliance with laws and regulations (USGAO 1994a, 1:11:9). These phenomena are comparative to the political environment discussed by Baber 1983, 1994 and Baber and Sen 1984. Baber (1994) summarizes prior studies and concludes that political competition affects accounting and auditing practices in various ways at the national, state, or local level. In our case, elected public ofcials (may) use accounting and auditing to ensure the QBE funds are allocated and spent according to specication. Although there is no direct
11. The responsibility and mission statements can be found at the Department of Audits and Accounts website at http://www2.state.ga.us/departments/audit/mission.htm and http://www2.state.ga.us/departments/audit/aboutus.htm. About 10 percent of school districts in our sample used private auditors.
12.
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link between performance of QBE funds and elected ofcials compensation, the state politicians have staked their reputations on the QBE funding process. Thus, we contend that the risk faced by elected ofcials is similar to that faced by the managers of rms who must relay credible information about their operations to current and potential investors. Datar, Feltham, and Hughes (1991) and Feltham, Hughes, and Simunic (1991) argue that when managers face high risks in disseminating information, the demand for high quality audits increases. We expect the same to hold for state politicians, and hence the demand for high quality governmental audits should increase after the implementation of the QBE Act. From a public economy point of view, the theory of administrativebased controls discussed by Bendor (1990) suggests that because bureaucrats may not always fulll elected ofcials desires, legislatures use accounting and auditing to constrain bureaucratic initiatives on the use of public resources. There have been seven major changes in QBE formulas in the twelve scal years since its implementation. These continual legislative changes in the complex QBE formulas are indicative of such behavior. Anecdotal evidence obtained via telephone conversations with a senior state auditor conrmed that QBE funds demanded signicant auditing time, partially due to the complexity of frequent changes in the QBE formulas. These complex compliance requirements come at a cost by creating additional demand for audit time. However, budget allocation is a political process (Baber 1983, 1994; Deis and Giroux 1994). If risk imposed to elected public ofcials is too low to ensure adequate governance, the amount of nancial resources allocated to auditing may be insufcient (Deis and Giroux 1994). Lack of an adequate budget creates roadblocks for auditors to assure that the audited nancial statements are not materially misstated and that an internal nancial control system is effectively implemented. Moreover, it is difcult for elected public ofcials or outsiders to understand the costs of QBE because information about auditing fees and auditing hours are not disclosed in public. However, the benets of QBE funds can be measured since the state department of education discloses the school districts performances. Summing the above, the political environment in budgeting process, risk imposed on elected ofcials, and the difference in the level of information disclosures provide a unique opportunity for us to closely examine the economic consequences of the implementation of QBE funds on audit effectiveness. Because there is no information about auditing fees charged to public schools and auditors effort specically exerted on QBE funds, we analyze audit efciency and effectiveness from the stakeholders point of view by examining whether auditing can reduce school districts nonproductive use of tax dollars.
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The monitoring effect of auditing Hypothesis 1 Auditors provide documentation when signicant deciencies exist in the design and operation of internal control structures. Such assessment should enhance internal monitoring and discourage inefcient use of public resources and potential perquisite consumption. According to Government Auditing Standards (USGAO 1994a), the responsibility of the Department of Audits and Accounts includes conducting performance audits, which determines whether public resources are acquired and used economically efciently. Any misallocation of QBE funds could result in a wealth transfer from taxpayers to public school ofcials at any level. An internal control system should constrain local school ofcials from indulging in inefcient activities, unauthorized transactions or the misuse of government resources, thereby enhancing resource allocation in the interest of society, as discussed by Liebenstein 1975, Lev 1988, and Penno 1990. Audits also play an external monitoring role. Auditors attestation in accordance with the pronouncements issued by GASB provides credibility in nancial reports. Financial information attested by auditors enables the elected public ofcials to communicate with outsiders about school districts performance under the QBE Act and to reduce contracting costs (Baber 1983, 1994; Baber and Sen 1984). We investigate the ability of audits to ensure the efcient use of school resources by examining the relationship between auditing effort and the unexplained portion of governmental expenditures that school districts could have used to increase students educational performance. Auditors increase the possibility of detecting misstatements and inefcient use of public resources. Therefore, if audits play a monitoring role, although they are not direct inputs to school district operations, they should reduce unexplained expenditures.13 To test this proposition, we utilize the relative performance evaluation technique. We estimate the relative nonproductive use of tax dollars, which measures the amount of student performance that school districts should have achieved if a district had used their budget purely to produce educational outcomes. If auditing helps to enhance the efcient use of school recourses, auditing should reduce nonproductive use of tax dollars, which is known to exist in public school district operations (Hanushek 1986; Grosskopf et al. 1997). Thus, our rst hypothesis is:
13.
It is possible to create scenarios under which the implied causality in the relationship between audit effort and nancial efciency could ow in either direction. That is, increased audit effort could increase nancial efciency just as increased nancial efciency could result in reduced auditor effort. In the current application the intuitively likely scenario is that increased auditing effort should impact the efciency with which tax dollars are allocated to the production of educational value added.
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Hypothsis 1. Auditing effort does not increase efcient use of tax dollars. The rejection of this null hypothesis suggests that auditing enhances the efcient use of public resources, and hence increases government accountability to the public. The roadblock effect Hypothesis 2 According to Government Auditing Standards (USGAO 1994a), auditing should determine whether an audited entity is acquiring, protecting, and using its resources economically and efciently. Accordingly, school auditing should improve efciency and generate economic benets for stakeholders. Auditing procedures in public school operations can, however, become very complex. QBE funds increases complexity due in part to legislators desires to produce taxpayers equity and equity of educational opportunities.14 But there is no requirement for the disclosure of auditing fees or auditing hours. This means that there is no information regarding a third party assessment of operational complexity. This makes it difcult for outsiders to determine sufcient budgets for auditing. Deis and Giroux (1994) suggest that an accounting system can be designed to include roadblocks in order for bureaucrats to control their operation. They found a negative association between educational expenditures and audit quality, supporting their prediction of roadblocks. We expand their notion of roadblocks by investigating whether the auditing complexity of QBE funds has an impact on audit effectiveness and by examining the effect of QBE and federal funds on the nonproductive use of tax dollars. The complexities created by QBE funds can be thought of as a roadblock that hinders auditors, preventing the assessment of how economically and efciently school districts utilize their resources. We choose QBE and federal funds as benchmarks for comparison because auditors level of experience may help to resolve weakening audit effectiveness arising from fund complexity. The distinct differences between QBE and federal funds are the dollar value in size per student and the auditors experience in complying with rules and regulations. Although federal funds require complex audit procedures, auditors have built up experience in compliance with these rules. In contrast, QBE funds presented a new and complicated challenge to auditors. These challenges are exacerbated by the constant changes to the rules over the short history of the legislation. Our second null hypothesis is: Hypothesis 2. There is no difference in the effects of QBE and federal funds on auditing effectiveness in the reduction of nonproductive use of tax dollars.
14. QBE funds seek to ensure both greater fairness to property taxpayers and equity of educational opportunity for all public school students (Harris 1986b, 55).
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4. Data description The Georgia Department of Education began to publish precise educational data at the school district level in the 1994 95 academic year in their annual Georgia Public Education Report Card. We collect three years of data (from the 1994 95 to the 1996 97 academic years) from this source. Because the Georgia Department of Education changed denitions and classication of variables over these three years, we had to reconstruct a consistent data set based on the denitions provided by the Department of Education (1996 97 Academic Year Georgia Public Education Report Cards).15 During this time period, GASB statements 25 through 31 were implemented. These statements require ner assessment of nancial risk and investment activities for governmental operations, thereby increasing the complexity of the auditing procedures.16 Georgia has a total of 181 school districts. Seven counties do not have a high school, and six of these seven do not have a junior high school. The students from these counties attend junior high or high schools in nearby counties. As sufcient data for these merged school districts are not available, these fourteen counties and one outlier are excluded from our analysis.17 A nal sample of 166 school district observations is available for each year (comprising a total of 498 observations). We use these school districts to estimate nonproductive use of tax dollars. Auditing time data (the hours spent on auditing) were collected from the Georgia Department of Audits and Accounts. Current regulations do not require auditors to keep a record of their auditing work, so data were only available for the 1996 97, 1997 98 and 1998 99 academic years. No auditing fee data were available because the Department of Audits and
15. One measure that changed was the test scores reported in the Report Cards. Despite criticism surrounding this change, the scores for a test given exclusively to students in the state of Georgia (GHSGT) are now reported. These test scores have no comparative measure with nationwide test scores (TAP), which were used in the report prior to the change. Along with others, we argue that the new test is sensitive to grade ination so that students in rural areas can receive HOPE scholarship to universities or colleges in the state of Georgia. This change makes it difcult for us to extend our data collection period. The TAP data are only available for 1994 95 and 1995 96 academic years. Therefore, we approximated a 1996 97 TAP score using the GHSGT. We calculated the ratio of TAP to GHSGT for every county using the average of the data for 1994 95 and 1995 96. Then, an approximation of the county TAP score for 1994 95 was computed as the product of the county GHSGT score and the ratio estimated above. The ratio of the 1994 95 TAP score to this estimated TAP score was reasonably close to one, which provides a reasonable estimate of TAP scores for the counties. For example, Statement 30 requires a risk nancing omnibus method to calculate deciencies for nancial risk, and Statement 31 requires reporting certain investments for external investment pools. The fourteen counties consist of the seven counties with no high school and the seven adjacent counties in which the combined schools are located. This results in 167 school districts. We drop an additional school because it was an outlier.
16.
17.
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Accounts does not charge auditing fees separately to each school district. Each year, approximately 20 school districts use private auditors, and no auditing data are available for these school districts. Therefore, these school districts were dropped from our sample. This results in a total of 145 school districts for each year.18 School performance data are based on the academic years 1994 95 to 1996 97. Prior studies suggest that public school operations are budget-based (e.g., Baber 1983, 1994; Chalos 1994) and the governmental budget process follows a similar pattern from year to year. This means that in the current period (t) school operations are based on a budget from time (t ) 1). The budget set at time (t ) 1) is audited in time period (t). It is then logically matched time (t ) 1) school data with time (t) audit data. Occasionally unexpended budget lapses will occur at the end of a scal year. This suggests that there is a very high correlation between budgets in time period (t ) 1) and current expenditure in time (t), which is conrmed by the data. For each budget (QBE, Federal, and Local), untabulated per student results indicate that all of the coefcient estimates for a rst order autoregressive model cannot reject the null hypotheses of the estimated coefcient equal to one, at the a level 0.01. This result indicates that (a) the current budget for a school district is based on prior periods budget and (b) year-to-year changes in student characteristics have a relatively small impact on auditing and budget allocations. This is consistent with the notion that once the school budget is allocated to each district, it will use up all available moneys. The year-by-year descriptive statistics for audit time, budgets, and student enrollment data are presented in Table 1. The statistics show that auditing time increased between the rst and second years but decreased between second and third years. The average dollar values of the funds per student and the average number of student enrollment increased over the three years. The proportion of QBE funds to the total budget is about 55 percent while the proportion of federal funds to total budget is about 10 percent and of local funds is approximately 30 percent. Each of those proportions is stable over the three years of data collected. 5. Research Design The selection of efciency estimation techniques Frontier estimation techniques employed by Grosskopf el at. 1997 and Dopuch et al. 2003 are used here to estimate inefciency and therefore the nonproductive use of tax dollars. Estimating the relative efciency of school district operations enables us to test whether auditing reduces inefciency in the use of school resources. We dene this type of auditors contribution as
18. Because our estimation method requires balance panel data and 21 school districts used private auditors in one year we eliminate all of these 21 school districts, resulting in the total of 145 school districts.
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efciency in auditing, which is different from that of Dopuch et al. 2003. However, resource allocation in the public sector is a political process. If auditing does not produce benets to interest groups (or taxpayers), there is no justication for allocating budgets to auditing activities as each aspect of governmental operations must compete for a share of the general budget. Thus, our denition is consistent with auditing under this competitive environment. It is well known that there is little incentive for bureaucrats to be efcient unless they are monitored (Hanushek 1986, 1996; Grosskopf et al., 1997). The relative efciency in school operations is estimated as a function of two types of observable input information. One is a vector of average student test scores at the school district level reported by the Department of Education, and the other is nancial information attested by the Department of Audits and Accounts. Following Grosskopf et al. (1997) and Grosskopf and Moutray (2001), we use a translog form of the cost distance function (CDF) to estimate efciency scores, using an ordinary least squares (OLS) error adjusted approach. While a few papers in the accounting literature have employed DEA analysis, the use of SFE in this body of literature is rare. The approach taken here is a modication of an OLS estimation technique suggested by Greene (1980). The OLS method is well understood. The modication used here explains efciency as a decomposition of the OLS error term into random and inefciency components. In the section on empirical results, several different approaches to efciency estimations are shown to be highly correlated.19 The CDF has a built-in interpretation as a performance measure, which consists of two components of errors, the random and inefciency components.20 It is also well-suited to the use of a exible functional form. This is a desirable property because production or cost functions for school districts are known to be nonlinear (e.g., Grosskopf et al. 1997). Moreover, Bauer, Berger, Ferrier, and Humphrey (1998) compare the results of several different frontier estimation techniques and suggest that the SFE approach provides results that more closely match a traditional accounting research method than do the results from DEA. Thus, the selection of OLS error adjusted approach maximizes our contribution to this area of accounting literature.
19.
20.
These estimations include an ordinary least squares (OLS) error-adjusted approach, SFE of error decomposition method, and DEA assuming both constant and variable returns to scale. Two different OLS error-adjusted approaches are specied using CobbDouglas and translog functional forms. The SFE is conducted only with a Cobb-Douglas functional form. Dopuch et al. (2003) provide a review of efciency estimation techniques. Interested readers should refer to their paper. The CDF models the technology of a public school that produce multiple outputs under conditions of budgetary constraint (Grosskopf et al. 1997, 117).
The Economic Value of Auditing and Its Effectiveness The empirical model for efciency
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School operations are based on and constrained by budgeted revenue. We incorporate this budget constraint by creating a vector of budget-deated input prices. The CDF is used to identify the benchmark school districts that produce the highest student value-added outcome given allocated budgets. In our setting, inefciency (departures from the benchmark) is a joint distribution of a school districts average student test scores and nancial information accredited by the Department of Education and the Department of Audits and Accounts, respectively. Since this efciency is estimated by the same model used by Grosskopf et al. (1997) for public school operation, we do not repeat the explicit illustration in this paper. But interested readers should refer to the above paper. The model is 1 wst ys IDo ; a; b est ; zst ; 1; jjyst jj cst jjyst jj where IDo is CDF with a translog functional form, || yst || is the outputs measure, yst is the vector of educational outputs (seven different kinds of student test scores), wist cst is the vector of budget deated input prices. Indices are for school districts (s = 1,, n) and for time (t = 1, 2, and 3). zst is an environmental variable, the student-to-teacher ratio. The est is the non-normally distributed error term composed of random error, m, and onesided error, l , dened as est = ms - lst. The educational output is estimated using a value-added method that controls for students socioeconomic factors, described in Grosskopf et al. (1997). It is well known that socioeconomic factors affect test scores, so we control for these factors. Our model yields 82 parameters with 36 restrictions, resulting in a total of 46 free parameters to be estimated. About 40 percent of the estimated parameters are signicant at a = 0.10. Our estimation also shows that all share equations are positive, indicating that the demand functions are positive when evaluated at the mean points. Built-in inefciency is captured by the negative non-normal component of error terms l.21 We illustrate how the efciency score is related to the nonproductive use of tax dollars using Figure 1, and show how the impact
21. OLS estimation is based on average observations and the underlying assumption that residuals from the regression model are normally distributed with zero mean and constant variance. This implies that there is no inefciency captured in regression residuals. In contrast, SFE tests for potential inefciency captured in residuals by estimating the frontier as indicated by the behavior of the best practicing school districts. Any deviations from the frontiers are potential inefciencies that are captured by additional component of residuals. SFE allows for a random component of errors in the estimation of inefciency while DEA assumes all deviations are inefcient. An adjusted OLS method is one type of SFE technique. Fa re, Grosskopf, and Lovell (1988) and Fa re and Grosskopf (1994, 1996) discuss various types of distance functions. Chambers (1988) discusses the production frontier and duality and Fa re and Primont (1995) discuss duality and output and input relationships. Interested readers are referred to these papers.
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of auditing on efciency scores (audit efciency) is estimated in output space. All school districts on the curved frontier are efcient and have a benchmark efciency score of one. School districts that fall inside of this frontier (y* and yo) do not utilize school budgets fully to increase student performance. The radial distance between the observed school district performance and the frontier measures inefciency. We directly estimate the impact of audits on this inefciency by estimating the corresponding reduction of radial distance. Since an audit is an independent outside-governance mechanism, it is not an input of efciency. However, for an audit to serve an effective monitoring function, it should reduce the inefciency as an outside governance mechanism. Empirical models to test the hypotheses If auditing plays a monitoring role, there should be an inverse relationship between auditing and inefciency. Our empirical model to test Hypothesis 1 is to regress auditing effort on efciency scores and examine whether an inverse relationship between auditing effort and nonproductive use of tax dollars (as measured by inefciency) exists. Our proxy for auditing effort is auditing hours. Based on prior studies (Deis and Giroux, 1994; Baber 1994; and Dopuch et al. 2003), we include two control variables, both of which are thought to signicantly affect the utilization of educational resources. The rst control variable is student test scores, specically the grade 11 mathematical test scores (TM). This variable should control for student characteristics (e.g., difculties in teaching) that inuence the performance of a specic program.22 The second is a proxy for size of the organization, which is the log form of student enrollment (LGTEN). The LGTEN is the most widely used school size proxy in educational studies and likely reects the size of local bureaucrats political constituency.23 Model A is: EFFi a0 a1 AUDTi a2 QBER a3 TMi a4 LGTENi ei 2;
where EFF is efciency scores, AUDT is auditing time and QBER is the percentage of QBE funds in the total budget allocated to a school district. Because EFF lies between zero and one, we estimate the model above using Tobit. A positive coefcient on a1 results in the rejection of null Hypothesis 1. We also examine the dollar value of auditing contribution to the improvement of efciency scores, which is a measure of the direct economic impact of monitoring. Inefciency can be interpreted as welfare loss for taxpayers interest groups. The rejection of null Hypothesis 1 suggests that
22. 23. We also use grade 11 reading test scores, instead of and in addition to TM. But the results remain the same. In the sensitivity analysis, we use an alternative proxy, which is the dollar value of the school districts budget. A similar variable is used by Baber (1983, 1994) and Deis and Giroux (1994).
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auditing has a signicant impact on the reduction of nonproductive use of tax dollars and provides evidence of successful monitoring. Hypothesis 2 tests whether complexity in audit procedures reduces audit effectiveness. QBE and federal funds are both complex funds. The auditing treatment of federal school funding has a long history and its rules have been relatively stable through the years. But QBE funding is more recent and fund allocation rules under QBE have been constantly changing. In this situation, auditors should have built-up skill in monitoring federal funds, but lack such expertise with QBE funds. This allows us to analyze two issues. First, if complexity in auditing reduces audit effectiveness, we should observe that the monitoring power of audits weakens as the high proportion of QBE funds in the total budget increases. Second, because of the expertise that auditors have for federal funds, the effect of federal funds on audit effectiveness should be minimal. Thus, by including an interaction term, we test Hypothesis 2 using Model B: EFFi a0 a1 AUDTi a2 AUDTi QBERi a3 AUDTi FEDRi a4 QBERi a5 TMi a6 LGTENi ei 3:
Complexity in auditing is reected by the proportion of QBE funds in the total budget (QBER), the proportion of federal funds (FEDR), and their interaction with auditing time (AUDT). A negative coefcient on either interaction term indicates that the effect of the complexity in auditing is to reduce school districts efciency in the use of resources. As the proportion of funds increases this negative effect amplies. A negative coefcient for QBER and a nonnegative coefcient for FEDR would suggest that the complexity of auditing procedures inherent in QBE funds reduces audit effectiveness, but the complexity of auditing procedures inherent in federal funds does not reduce audit effectiveness. If the coefcient is negative in both cases, it indicates the reduction in effectiveness from both sources of funding. A third alternative is that the estimated coefcients are positive on both variables. In this case, both funds help elected ofcials to attain their goal despite the extra burden for auditors. 6. The empirical results Descriptive statistics The descriptive statistics for the 489 observations of school district variables are shown in panel A of Table 2. The average expenditure for teaching and student-related activity is approximately $4,000 per student. The average enrollment is about 7,600, which is much larger than reported in Table 1. This indicates that school districts that hire private auditors have large enrollments. The proportion of students who participated in a free lunch program, LUNP, shows a large deviation from 6 percent to almost 90 percent of students. This suggests that the level of parent family wealth varies widely across school districts. Similarly, average student mathematical test
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TABLE 2 Descriptive statistics and correlation among estimated efciency scores Panel A: Descriptive statistics for all 498 observations Variable
TOT1R SPSAL TEASAL CPI TENR LUNP TM STUTEA EFF Notes: Variable denitions are as follows: TOT1R is the teaching and student related expenses per student; SPSAL is the average of support staff salaries; TEASAL is the average of teachers salaries; CPI is the price for materials related to teaching and students; TENR is the total student enrolment; EFF is the estimated nonproductive use of tax dollars (efciency score), LUNP is the proportion of students participating in the free lunch program in total population, TM is student mathematical test scores at grade 11, and STUTEA is the student-to-teacher ratio. Panel B: Correlation in efciency scores among different estimation techniques VRS VRS Cobb_OLS Cobb_SFE Translog_OLS Notes: VRS is the efciency score employing the variable return to scale model in DEA. Cobb_OLS is the efciency score employing a Cobb-Douglas function in OLS erroradjusted-method. Cobb_SFE is the efciency score employing a Cobb-Douglas function in the error decomposition method. Translog_OLS is the efciency score employing a Translog function in the OLS erroradjusted method. The upper triangle is Pearson and lower triangle is Spearman Rank correlation. All values are signicant at the a = 0.0001 level (two tailed). 1.00000 0.77459 0.79175 0.59721 Cobb_OLS 0.77658 1.00000 0.99475 0.77458 Cobb_SFE 0.72913 0.95890 1.00000 0.76596 Translog_OLS 0.58814 0.72622 0.69129 1.00000
Mean
$4,064.81 $38,265.03 $32,300.59 $154.607 7602.03 0.4869 53.9016 16.1504 0.9129
Std
$426.948 $3,343.23 $2,426.81 $3.474 13459.91 0.1631 10.4716 1.2533 0.0187
Median
$4,035.90 $38,117.40 $32,083.50 $154.50 348.35 0.4928 54.00 16.1421 0.9116
Minimum
$2,594.43 $29,539.50 $26,673.40 $150.410 4750.00 0.0627 21.00 8.1121 0.8622
Maximum
$5,677.81 $49,856.50 $39,995.02 $158.910 90311.00 0.8971 87.00 21.9483 1.0000
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scores for grade 11, TM, and student-to-teacher ratios, STUTEA, vary widely across school districts but not as widely as that of parent family wealth level. Although not reported in the tables, the salary for teachers is the largest portion of expenditure, which represents about 38 percent of the total budget accounted for our analysis. The three-year average efciency score (EFF) is approximately 91 percent, which is higher than that reported for Texas school districts examined by Grosskopf et al. (1997). They found a mean efciency score of 70.8 percent. This difference reects differences in characteristics of the data. Grosskopf et al. restrict their samples by school size (measured by student enrollment to be between 1,000 and 5,000 students).24 Panel B of Table 2 shows the correlation among the efciency scores estimated by four different frontier estimation techniques: variable returns to scale (VRS) is an efciency score estimated by DEA; two stochastic methods are SFE and the OLS error-adjusted method, within which two functional forms are estimated, the Cobb-Douglas (Cobb_SFE, Cobb_OLS) and Translog (Translog_OLS).25 The four efciency scores are very highly correlated, especially the efciency scores from the two stochastic methods (Cobb_SFE, Cobb_OLS). These correlations provide evidence that the estimated efciency scores are robust to different estimation techniques. In presenting our results we will use the Translog_OLS efciency scores. According to Bauer et al. (1998), the stochastic approach provides results that more closely match a traditional accounting research method than do the results from DEA. Panel A in Table 3 presents the mean efciency scores for all school districts that have audit data. The variable EFFAUD (= 0.9119) is the mean efciency score for the 435 school districts over three years. The variable EFF95 96 (= 0.9118) is the mean efciency score for the 294 school districts over a two-year period (the 1995 1996 and 1996 1997 academic years). The mean efciency score increases between the 1994 95 (EFF94) and 1995 96 (EFF95) academic years from 0.9121 to 0.9142, but it decreases between the 1995 96 and 1996 97 (EFF96) academic years from 0.9142 to 0.9096. To better understand the impact of inefciency on the use of public resources, we calculate the opportunity costs arising from school districts operating at less than efcient levels. This gives us a means of quantifying the nonproductive use of tax dollars. Among all school districts, the average expense per student is $4,064.81 and the three-year average efciency score is 0.9119. This means that the average level of inefciency is
24. As shown in Table 1, the sample used here has an average enrollment of 7,602 with a standard deviation of 13,460. The Georgia data cover all school districts in the state and hence, contain more variations in student and school-related factors. Because of the restrictions on share equations, we could not estimate efciency scores based on the translog form using the SFE approach. We use a software package called Frontier by Coelli as well as TSP to write our own program to estimate efciency scores based on SFE technique.
25.
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TABLE 3 Descriptive statistics for estimated efciency scores and related variables Panel A: Estimated efciency scores (Translog _OLS) Variable EFFAUD EFF95 96 EFFA94 EFFA95 EFFA96 Notes: EFFAUD is the efciency scores for school districts that have used state auditors for all three years. EFF95 96 is the efciency scores for school districts in the 1995 96 and 1996 97 academic years, which are used to analyze the hypotheses. EFFA94 is the efciency scores for school districts in the 1994 95 academic year. EFFA95 is the efciency scores for school districts in the 1995 96 academic year. EFFA96 is the efciency scores for school districts in the1996 97 academic year. Panel B: Variables in the model for hypothesis tests Obs AUDT TOT1R QBER FEDR QBES FEDS LGTEN TENR TM Notes: AUDTt is the auditing time. TOT1R is the teaching and student related expenses per student. QBER is the percentage of QBE funds in total budget allocated to a school district. FEDR is the percentage of federal funds in total budget allocated to a school district. (The table is continued on the next page.) CAR Vol. 27 No. 2 (Summer 2010) 294 294 294 294 294 294 294 294 294 Mean 599.1599 $4144.86 0.5433 0.0977 $3002.88 $544.60 8.1609 5296.65 53.8061 STD 298.9268 $376.98 0.0993 0.0319 $326.39 $174.73 0.8147 8346.56 10.1187 Minimum 173 $3248.99 0.1756 0.0296 $1037.35 $173.99 6.1633 475.00 24 Median 545 $4125.30 0.5653 0.0970 $3033.84 $539.34 8.0863 3249.50 54 Maximum 2474 $5657.00 0.7705 0.1689 $4262.17 $981.15 11.4110 90311.00 87 Obs 435 294 145 145 145 Mean 0.9119 0.9118 0.9121 0.9142 0.9096 STD 0.0169 0.0162 0.0183 0.0169 0.0152 Minimum 0.8622 0.8622 0.8698 0.8703 0.8622 Maximum 0.9725 0.9725 0.9713 0.9725 0.9613

TABLE 3 (Continued) LGTEN is the log form of the total enrollment for a school district. QBES is the dollar value of QBE funds allocated to school districts per student. FEDS is the dollar value of FEDERAL funds allocated to school districts per student. TM is mathematics test scores for grade 11.
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about 8.8 percent. Since the efciency scores are scale free measures, 8.8 percent inefciency can be converted into a dollar value, which is equivalent to the nonproductive use of tax dollars of approximately $360 per student each year. At the statewide level, the nonproductive use of tax dollars is equivalent to a total cost of $271 million to taxpayers each year.26 Thus, although inefciency of less than 10 percent sounds small, it is quite large when put into statewide dollar terms. Panel B presents descriptive statistics for the characteristics of school districts and audit hours, both of which are included in the model to test the hypotheses. We use two years of school data, 1995 96 and 1996 97, and audit hours for the 1996 97 and 1997 98 academic years to conduct the hypothesis tests.27 There are a total of 294 observations. The average auditing time is about 600 hours. The two-year average teaching and studentrelated expenses per student are about $4,145 and approximately 75 percent of these expenses are from QBE funds. The average federal funds allocated per student are $545. The average proportion of QBE funds in all budgets allocated to school districts is 54 percent, with federal funds averaging 9 percent of the budget. An average total student enrollment is 5,297. The results of the hypotheses tests Table 4 presents the results for the two models, A and B, one with no interaction terms (Model A) and the other including interactions of auditing time with both the percentage of QBE funds and the percentage of federal funds in the total budget (Model B). Based on the results in Table 4, we reject null Hypothesis 1. The fundamental relationship between auditing
26. The dollar value of inefciency is calculated as follows: (1 ) 0.9119)*4,061.81 = 357.845 per student, and in terms of an annual average across the 145 schools, 357.845*5,222*145 = 270,957,004. Note that the total student enrollment is 5,222 in this calculation. This is because the efciency score 0.9119 is the three-year average and the corresponding student enrollment is 5,222, not 5,297 as reported in Table 3. The sample for this analysis consists of 145 school districts rather than the 166 analyzed in the previous section. Because 21 school districts used private auditors, and thus data on auditing time were unavailable. Thus, these 21 districts were dropped from the data set for these tests. We also conduct the analysis using all three-year observations with a two-year lag between schools and auditing data. Our main results remain the same.
27.
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TABLE 4 Tobit models used to test hypotheses. EFFi = a0 + a1AUDTi + a2QBER + a3TMi + a4LGTENi + ei
EFFi a0 a1 AUDTi a2 AUDTi QBERi a3 AUDTi FEDRi a4 QBERi a5 TMi a6 LGTENi ei

Panel A: The coefcient estimations Parameter INTER AUDT AUDTQBER AUDTFEDR QBER TM LGTEN Log likelihood Notes: EFF is the efciency score multiplied by 100. AUDT is the auditing time, hours spend on auditing. AUDTQBER is the interaction of auditing time and the percentage of QBE funds to total budget, AUDTFEDR is the interaction of auditing time and the percentage of federal funds to total budget, TM is the grade 11 student mathematical test scores, and LGTEN is the log form of the total enrollment for a school district. QBER is the percentage of QBE funds in total budget allocated to a school district.
a
Model A (SE) 92.9127*** (1.2377)a 0.0012** (0.0004)
Model B (SE) 85.9662*** 0.0076*** )0.0174*** 0.0206*** 9.2323*** 0.0711*** )0.4686*** )528.1949 (1.6331) (0.0015) (0.0031) (0.0049) (2.0086) (0.0094) (0.1450)
)0.1939 (0.9425) 0.0535*** (0.0092) )0.6399*** (0.1448) )536.9900
The values in parentheses are standard errors.
SE = standard error. There are 294 total observations for the 1995 56 and 1996 97 academic years. *,**, *** Signicant at the a 0.1, 0.05, 0.001 levels (two-tailed). Panel B: Marginal economic effects of complexity on audit effectiveness. Variables AUDTQBER_lower quartile Calculation (0.0076 ) 0.0174*0.49 + 0.0206*0.0977) Total effect 0.001087 )0.000224 )0.001095 Dollar value $34,600 )$7,100 )$34,900
AUDTQBER_Median (0.0076 ) 0.0174*0.5653 + 0.0206*0.0977) AUDTQBER_Upper quartile (0.0076 ) 0.0174*0.6154 + 0.0206*0.0977)
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and efciency scores is positive and signicant (at the 0.001 percent level) as shown by the estimated coefcient on auditing time a1 in Model A. This positive coefcient indicates that, independent of the impacts on audit effectiveness from either QBE or federal funds, auditing provides economic benets for taxpayers and interests groups by reducing nonproductive use of tax dollars. Next, in Hypothesis 2 we test whether the complexity of each fund becomes a roadblock for auditors and reduces the economic benets of auditing. When both interaction terms are included (Model B), the coefcient on AUDT a1 is still positive and signicant (0.0076). The test of Hypothesis 2 is shown in the estimated coefcient on the interaction term AUDTQBER, which is negative ()0.0174). This is in contrast to the sign on an interaction term AUDTFEDR, which is positive (0.0206). In addition, once interaction terms are included in the model, the coefcient on QBER becomes signicantly positive (9.2323). These results indicate that a direct effect of QBER is to increase utilization of school resources to improve student performance. However, QBER reduces auditing effectiveness. As the proportion of QBE funds in the total budget increases, the effect of auditing on nonproductive use of tax dollars decreases. On the other hand, as the proportion of federal funds increases, the effect of auditing increases. Since QBE funds are new for auditors, this result suggests that complexity in QBE funds reduces auditing effectiveness.28 The marginal effect of auditing is 0.0076 ) 0.0174 QBER + 0.0206 FEDR. Evaluated at the means, the effect of auditing on efciency scores is positive, 0.00016.29 QBER lies between 17 percent and 77 percent of the school budgets, and the coefcient is negative, )0.0174. This means that if a school district has a large proportion of QBE funds (relative to the mean), this can reduce audit effectiveness. These results serve to reject null Hypothesis 2. Given the level of auditing time, as the proportion of QBE funds in the total budget increases, the nonproductive use of tax dollars also increases. However, the complexity in auditing procedures for federal funds does not reduce audit effectiveness. The coefcient on student test scores (TM) is positive for both models, indicating that school districts with students starting at a higher level of achievement utilize school resources more efciently. The coefcient on student enrollment is negative, indicating that larger districts are less efcient in their use of educational resources.
28.
29.
We note that when we include FEDR in the model 3, the coefcient on the interaction term AUDTFEDR became insignicant and the coefcient on FEDR is signicantly positive. This result weakens the strong contrast. However, the fundamental conclusion does not change: auditors experiences about specication of funds would help to improve auditing effectiveness. This is calculated as 0.0076 ) 0.0174*0.5433 + 0.0206*0.0977 = 0.000159.
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Calculation of dollar value impacts We calculate the dollar value of the contribution of auditing by measuring the reduction in the nonproductive use of tax dollars. Previously, we showed that inefciency of 8.8 percent in the use of tax dollars is equivalent to a total annual cost of $271 million to taxpayers. Similarly, we calculate the impact of the estimated coefcients on efciency scores in dollar value terms. The estimated coefcients on AUDT shown in Model B are 0.0076 AUDT ) 0.0174 AUDTQBER + 0.0206 AUDTFEDR. Because the average auditing hours are 599 for the two academic years between 1996 97 and 1997 98, the auditing effect on the efciency score is 0.095 percent.30 Although this percentage may seem small, when converted to dollar values it appears more substantial. Since the two-year average expenditure per student is $4,144.86 and average student enrollment is 5,297 for each of the 145 school districts, the total reduction in the nonproductive use of tax dollars per year for the state becomes approximately $3 million.31 This amount is equivalent to the reduction of nonproductive use of tax dollars illustrated in Figure 1. Ceteris paribus, the distance between y* and y0 is the audit effect (audit efciency) that results in the reduction of nonproductive use of tax dollars. More importantly, the effect of auditing on the efciency score is small because of the negative coefcient of AUDTQBER. This negative effect on efciency scores is 5.66 percent that is to reduce the efcient use of tax dollars. Converting this into dollar value yields $180 million increase in the nonproductive use of tax dollars due to the reduction of auditing effectiveness.32 We also examine the marginal effect of the negative coefcient of AUDTQBER on audit effectiveness. We calculate the impact of the negative coefcient on the interaction term on efciency scores for three groups of school districts. Since the proportion of QBE funds is our proxy for complexity in audit procedure arising from QBE funds, by varying the level of QBE funds in total budget (QBER), we can assess the effect of complexity
30. This is calculated as 0.0076*599 ) 0.0174*325.5 + 0.0206*58.5 = 0.095, where 599 is the two-year average auditing time in hours, 325.5 is the average of AUDTQBER, and 58.5 is the average of AUDTFEDR. The average nonproductive use of tax dollars per student year for the 145 school districts is 573.276. The calculation for the total dollar amount is 0.00095*4144.86*5297*145 = 3,036,442, the auditing effect * an average expenditure per student * the average number of students per school district* the numbers of school districts, respectively. The calculation is )0.0174*325.5 = )5.66, and converted into dollar terms becomes )5.66 100*4,144.86*5,297*145 = )180,306,273. Assuming that specic funds do not affect audit efciency, auditing effect in dollar value is 145 million, 4.55 100*4,144.86*5,297*145 = 144,955,760. The dollar value of auditing effect on federal funds is 38.4 million, 1.21 100*4,144.86*5,297*145 = 38,386,955. The net result is auditing reduces the nonproductive use of taxes dollars by $3 million. This calculation shows that the impact of complexity in QBE funds on audit contribution is large.
31.
32.
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for different groups of school districts. The rst group contains the school districts in the lowest quartile with respect to QBER (49 percent), the second contains those in the median QBER (57 percent), and the third contains those in the upper quartile (64 percent). The impact of a one-hour increase of auditing on efciency scores and dollar value is reported in panel B of Table 4. This panel shows the economic effect of complexity in QBE funds on the use of tax dollars, assuming all variables are evaluated at their means except for QBER. The positive effect on efciency for a school in the lowest quartile QBE fund districts is 0.001087, which translates to an average $34,600 increase in the economic benet of auditing.33 For the median school districts, on the other hand, the complexity in QBE funds increases the nonproductive use of tax dollars by $7,10034 and for the upper quartile school districts by $34,900.35 These results indicate a signicant effect of complexity in auditing procedures on the use of tax dollars. It shows that the impact of a roadblock on school district operations varies according to the size of the QBE receipts of each school district. Sensitivity analysis using the DEA technique and political factors implication To test the robustness of our results, we reestimate Models A and B using efciency scores based on the variable returns to scale (VRS) of the DEA model. The efciency scores estimated by DEA have smaller variation among school districts than those of OLS error-adjusted methods. About 10 percent of the school districts (24 observations) are deemed to be efcient. However, as shown in Table 2, the correlation among efciency scores from the different estimation approaches is high. The lowest correlation is 59 percent, between VRS DEA and the Translog form of OLS error-adjusted method. As expected, the fundamental results remain similar to those reported in Table 4. The estimated coefcient on auditing is positive, supporting our previous conclusion that auditing reduces nonproductive use of tax dollars and thereby has a real monitoring effect. There is also a negative coefcient on the interaction terms with QBER and a positive coefcient on the interaction terms with FEDR, indicating that complexity together with a lower level of auditor experience leads to reduce auditing effectiveness. Our results are in contrast to Dopuch et al. 2003 who nd inconsistent results between stochastic and DEA models. We suspect that their difference arises from the use of a constant return-to-scale DEA model that assumes a proportional increase in all inputs results in the same proportional increase in outputs. We also consider the potential inuence of political factors on audit effectiveness and efciency scores. If political factors affect efciency scores and are correlated with audit effectiveness, there is an omitted variable
33. 34. 35. The calculation is 0.0000010866*4,144.86*5,297*145 = 34,600. The calculation is )0.000002236*4,144.86*5,297*145 = )7,100. The calculation is )0.0000109528*4,144.86*5,297*145 = )34,900.
664
problem. To examine the inuence of political factors, we further reestimate Models A and B using the dollar value of the school districts budget per student. Baber (1983, 1994) and Deis and Giroux (1994) suggest that the dollar value of budget captures the inuence of the political environment in government operations. However, the signs of the estimated coefcients of AUDT, AUDTQBER and AUDTFEDR do not change. 7. Conclusions In this study, we examine the effect of auditing on public school resources used in the period subsequent to the implementation of the QBE Act in the State of Georgia. We utilize a unique educational reform opportunity where elected ofcials pledged to improve the quality of the public school system. As a result of this promise, various new monitoring structures were implemented. This provides an ideal setting to examine the economic benets of auditing and the effect of new complex compliance rules on audit effectiveness. We provide direct evidence that auditing produces economic benets for stakeholders as indicated by reductions in the nonproductive use of tax dollars. Our method of estimating audit efciency enables us to calculate the economic value of auditing to taxpayers and or interest groups, which is an annual average of approximately $145 million. We also show that complexity in audit procedures reduces audit effectiveness and hence increases the nonproductive use of tax dollars. In particular, our results show that when compliance rules are new and continuously changing (i.g., complexity is increasing), auditing effectiveness drops; when compliance rules are static and auditors have built up experience with these rules, auditing effectiveness is stable. We nd that complex compliance rules can become a roadblock and reduce the monitoring effect of audits. This research thus implies that it is important to consider potential roadblocks for auditors when evaluating auditing effectiveness, the economic value of auditing and when new regulation alters existing auditing practices. Auditing clearly contributes to greater efciency in the use of public school budgets. Our results reinforce the notion that auditing is important for government accountability for public education funding. The efciency of school resource allocation is often overlooked in the politically charged environment of public school funding. Our results indicate that greater transparency and reduced complexity in the use of funds and continued auditing efforts will improve overall efciency in the use of public education budgets. References
Baber, W. R. 1983. Toward understanding the role of auditing in the public sector. Journal of Accounting and Economics 5 (3): 21327. Baber, W. R. 1994. The inuence of political competition on governmental reporting and auditing. Research in Governmental and Nonprot Accounting 8: 10927.
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Baber, W. R., and P. K. Sen. 1984. The role of generally accepted reporting methods in the public sector. Journal of Accounting and Public Policy 3 (2): 91106. Banker, D. R. 1989. Econometric estimation and data envelopment analysis. Research in Governmental and Nonprot Accounting 3: 23143. Banker, D. R., H. Change, and R. Cunningham. 2003. The public accounting industry production function. Journal of Accounting and Economics 35 (2): 25581. Banker, D. R., W. W. Cooper, and G. Potter. 1992. A perspective on research in governmental accounting. Accounting Review 67 (3): 496510. Battese, G. E., and T. Coelli. 1995. A model for technical inefciency effects in a stochastic frontier production function for panel data. Empirical Economics 20 (2): 32532. Bauer, W. P., A. N. Berger, G. D. Ferrier, and D. B. Humphrey. 1998. Consistency conditions for regulatory analysis of nancial institutions: Comparison of frontier efciency methods. Journal of Economics and Business 50 (2): 85114. Bendor, J 1990. Formal models of bureaucracy: A review. In Public Administration: The State of the Discipline, eds. N. B. Lynn and A. Wildavsky, 373417. Chatham, NJ: Chatham House. Chalos, P. 1994. Commentary on Donald R. Deis and Gray A. Giroux. Research in Governmental and Nonprot Accounting 8: 22934. Chambers, R. G. 1988. Applied production analysis: A dual approach. Cambridge, UK: Cambridge University Press. Datar, S. M., G. A. Feltham, and J. S. Hughes. 1991. The role of audits and audit quality in valuing new issues. Journal of Accounting and Economics 14 (1): 349. Dayton, J., and K. Matthews. 1995. Georgia school nance: Funding education in the new empire of the South. ERIC# ED385939. Washington, DC: Educational Resource Information Center, U.S. Department of Education. Deis, D. R., and G. A. Giroux. 1992. Determinants of audit quality in the public sector. Accounting Review 67 (3): 46279. Deis, D. R., and G. A. Giroux. 1994. The size of budgets and audit quality of independent school districts. Research in Governmental and Nonprot Accounting 8: 21327. Dopuch, N., and M. Gupta. 1997. Estimation of benchmark performance standards: An application to public school expenditures. Journal of Accounting and Economics 23 (2): 14161. Dopuch, N., M. Gupta, D. Simunic, and M. T. Stein. 2003. Production efciency and the pricing of audit services. Contemporary Accounting Research 20 (1): 4777. Fa re, R., and S. Grosskopf. 1994. Cost and revenue constrained production. Berlin: Springer-Verlag. Fa re, R., and S. Grosskopf. 1996. Intertemporal production frontiers with dynamic DEA. Boston: Kluwer Academic Publishers. Fa re, R., and D. Primont. 1995. Multi-output production and duality: Theory and applications. Boston: Kluwer Academic Publishers. Fa re, R., S. Grosskopf, and C. A. K. Lovell. 1988. An indirect approach to the evaluation of producer performance. Journal of Public Economics 37 (1): 7189.
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Feltham, G. A., J. S. Hughes, and D. Simunic. 1991. Empirical assessment of the impact of auditor quality on the valuation of new issues. Journal of Accounting and Economics 14 (4): 37599. FitzGerald, S. 1991. ABCs of school nance in Georgia, 3rd ed. Atlanta: League of Women Voters of Georgia, Inc. Gauthier, S. 1991. Auditing in local government nance: Concepts and practices, eds. J. Petersen and D. Strachota. Chicago: Government Finance Ofcers Association. Georgia Public Education Reports Cards. 199495, 199596, 199697. Atlanta: Accountability Unit, Georgia Department of Education. http://www.doe.k12. ga.us. Georgia Department of Audits and Accounts. 2000a. Mission Statement. http:// www2.state.ga.us./departments/audit/mission.htm. Georgia Department of Audits and Accounts. 2000b. http://www2.state.ga.us./ departments/audit/aboutus.htm. Greene, W. H. 1980. Maximum likelihood estimation of econometric frontier functions. Journal of Econometrics 13 (1): 2756. Grosskopf, S., K. J. Hayes, L. L. Taylor, and W. L. Weber. 1997. BudgetConstrained frontier measures of scal equality and efciency in schooling. Review of Economics and Statistics 79 (1): 11624. Grosskopf, S., and C. Moutray. 2001. Evaluating performance in Chicago public high schools in the wake of decentralization. Economics of Education Review 20 (1): 114. Hanushek, E. A. 1986. The economics of schooling: Production and efciency in public schools. Journal of Economic Literature 24 (3): 114177. Hanushek, E. A. 1996. School resources and school performance. In Does Money Matter? The Effect of School Resource on Student Achievement and Adult Success, ed. G Burtless. Washington, DC: Brookings Institution Press. Harris, J. F. 1986a. In Georgia ... quality basis education. NASSP Bulletin 70 (491): 36, 3840. Harris, J. F. 1986b. The governors plan for achieving quality basic education. Atlanta: Governors Ofce of Planning and Budget, State of Georgia. Ingram, R. W. 1984. Economic incentives and the choice of state government accounting practices. Journal of Accounting Research 22 (1): 12644. Keating, E., M. Fischer, T. Gordon, and J. Greenlee. 2005. The single audit act: How compliant are nonprot organizations? Journal of Public Budgeting, Accounting, and Financial Management 17 (3): 285309. Liebenstein, H. 1975. Aspects of the x-inefciency theory of the rm. Bell Journal of Economics and Management Science 6: 580606. Lev, B. 1988. Toward a theory of equitable and efcient accounting policy. Accounting Review 63 (1): 120. Mensah, Y. M., and S. Li. 1993. Measuring production efciency in a not-for-prot setting: An extension. Accounting Review 68 (1): 6688. Penno, M. 1990. Auditing for performance evaluation. Accounting Review 65 (3): 52036.
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The Economic Value of Auditing and Its Effectiveness in Public School Operations*

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

EFFi a0 a1 AUDTi a2 AUDTi QBERi a3 AUDTi FEDRi a4 QBERi a5 TMi a6 LGTENi ei

Model A (SE) 92.9127*** (1.2377)a 0.0012** (0.0004)

)0.1939 (0.9425) 0.0535*** (0.0092) )0.6399*** (0.1448) )536.9900

The values in parentheses are standard errors.

AUDTQBER_Median (0.0076 ) 0.0174*0.5653 + 0.0206*0.0977) AUDTQBER_Upper quartile (0.0076 ) 0.0174*0.6154 + 0.0206*0.0977)

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

Contemporary Accounting Research

CAR Vol. 27 No. 2 (Summer 2010)

The Economic Value of Auditing and Its Effectiveness

CAR Vol. 27 No. 2 (Summer 2010)

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Model A (SE) 92.9127* (1.2377)a 0.0012 (0.0004)

)0.1939 (0.9425) 0.0535* (0.0092) )0.6399* (0.1448) )536.9900

AUDTQBER_Median (0.0076 ) 0.01740.5653 + 0.02060.0977) AUDTQBER_Upper quartile (0.0076 ) 0.01740.6154 + 0.02060.0977)