Mike Shor: Research




Local Preference in Municipal Audit Markets

with Karl Hackenbrack

Revised July 2008


Abstract

We investigate the influence of local preference policies on auditor selection in the municipal audit market. A local preference occurs when local firms are favored in audit procurement over non-local firms for reasons unrelated to the audit itself. We construct four auction models of the competitive bidding process differentiated by possible objectives of the municipality: cost minimization versus surplus maximization and with or without a local preference policy. Which model is most descriptive is ultimately an empirical question. We generate predictions that allow for empirical identification and find evidence of local preference. We use the identified model to analyze theoretically the unobservable net audit-related effect of a municipality adopting a local preference policy. We show that a local preference policy can benefit even a municipality guided solely by audit-related concerns by encouraging price concessions from non-local auditors.