A basic study of agency-cost source and municipal use of internal versus external control

Abstract

This study examines the association between agency-cost source and the use of internal control versus external control in municipal control systems. Specifically, I focus on the differences between internal and external control to determine whether characteristics of underlying organisations might lead to differential demand for internal and external control. Differential demand is argued to be linked to the manager's position as principle or agent (or alternatively the presence of internal or external agency costs, respectively). Internal control is posited to be used specifically to address internal agency costs; external control is posited to be used specifically to address external agency costs. Results are consistent with these hypotheses. Cities facing high levels of agency costs from voters and creditors tend to hire Big 5 auditors or auditors with municipal experience, but generally do not employ internal auditors or certified finance officers. Also, cities facing high levels of agency costs from employees tend to employ internal auditors or certified finance officers, but generally do not hire Big 5 auditors or auditors with municipal experience. There does not appear to be widespread substitution of internal and external control to address agency problems in municipal organisations. For data availability contact the author.