The Role of Federal Agency Accounting Quality in Federal Budget Allocation: Evidence From Audit Opinions

Politicians allocate substantial resources among federal government agencies through budgeting, yet little empirical evidence exists regarding whether accounting quality of federal agencies plays a role in this political process. Using audit opinions on agency financial statements to measure accounting quality, I find that when an agency receives a modified audit opinion, the president proposes and Congress passes a lower budget for the agency, and the budget disagreement between the president and Congress increases. These effects are stronger when politicians (the president and Congress) have stronger incentives to demonstrate accountability in federal spending. To enhance identification, I exploit the enactment of the Department of Homeland Security (DHS) Audit Requirement Target Act, which mandated DHS to end its long-lasting modified audit opinions. I find that the president proposes a higher budget for DHS, and the budget disagreement for DHS decreases after the Act. These findings suggest that higher-quality federal agency accounting plays an important role in federal budgeting by reducing information asymmetry between bureaucrats (agencies) and politicians.