Political and organizational legitimacy of public sector auditing in New Zealand local government

3.1. Power’s schema

Power’s (2003) essay explores four themes in contextualist and critical audit research, focusing on the production of legitimacy. Legitimacy is required at the level of the individual practitioner and at the level of field of practice, with the legitimacy of the auditor and the legitimacy of an audit practice considered co-produced. The introduction of auditing into new areas is the fourth theme that Power discusses, and is the focus of this study. Following Radcliffe (1999), Power suggests that when audit receives a new mandate it allows for professional reinvention and a “new legitimacy in the management hierarchy of control agents” (Power, 2003: 387). Part of the process involves the acceptance of the knowledge basis of the auditor qua institution, prior to the acceptance of the individual auditor’s knowledge basis and legitimacy.

Drawing on existing studies and based on categories currently in use in the social science literature (controversy, closure and credibility), Power (2003) provides an explanatory schema for addressing the acceptance and/or rejection of proposed auditing practices and arrangements. Controversy requires some event or crisis that will lead to a disturbance of the status quo. For the disturbance of the status quo to become a controversy there are two necessary conditions; a proposal that is different from the status quo, and the existence of a sufficiently influential group of supporters for it to become a serious challenge to the status quo. Closure occurs when the controversy becomes the new status quo by obtaining consensus of those involved. An audit technique only becomes accepted as a “good” technique once closure has been obtained. Credibility, the final step, is the linking of the new status quo with some external knowledge or practice. Credibility is often obtained through connections with external forces such as regulatory systems or alignment with particular bodies of knowledge or communities that have currency at the time. This step is important as it makes the new arrangement appear “natural, obvious and temporarily at least, uncontested” (Power, 2003: 392).

Central to the utility of Power’s (2003) schema is its ability to help describe how auditing can gain legitimacy by reference to terms other than those explaining or describing auditing or aspects thereof. By using the three stages of controversy, closure and credibility, the use of terminology from auditing itself is avoided. We are neither tempted nor forced to use terms such as ‘independence’ and ‘professional’ to explain an activity that aspires, describes and judges itself with these same words. Power’s (2003) explanatory schema’s use of terms that are abstracted from the particular protects “the researcher from being slave to the concepts and categories of the audit field itself” (Power, 2003: 390), while still providing “three guiding themes” (2003: 392) on how legitimacy is achieved.

This study combines Power’s (2003) abstract schema with concepts from literatures on political legitimacy and organizational legitimacy that point to specific factors that contribute to gaining and losing legitimacy. Power (2003) provides a frame for discussing how the auditing practices gain or fail to gain legitimacy, while the use of concepts from political and organizational legitimacy literatures allows the various acts and actors to be classified according to how they contribute to the legitimacy of the audit arrangements. The remainder of this section outlines the nature of political legitimacy and organizational legitimacy. Figure 1 outlines the typologies of organizational legitimacy based on Suchman (1995) and political legitimacy based on Levi et al. (2009).

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Figure 1.

Political and organizational legitimacy typologies.

3.2. Organizational legitimacy

The legitimacy of an organization is often described in terms of a relationship between the entity and the public, or part thereof, that grants legitimacy to the entity or its actions. According to Suchman (1995: 574), legitimacy can be viewed as “a generalized perception or assumption that the action of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions”. Suchman (1995) identifies three types of organizational legitimacy; pragmatic, moral and cognitive. These three types all acknowledge the socially constructed nature of legitimacy, but illustrate that different factors motivate or otherwise create the perception or assumption that leads to legitimacy being granted to the organization or its actions.

Pragmatic legitimacy is granted when an audience views the organization as legitimate because it is in the audience’s best interest to do so. Suchman further divides pragmatic legitimacy into three subtypes: exchange, influence and dispositional. Exchange legitimacy is granted when there is an expected return of some value to those in a position to grant legitimacy. The gain could be obvious, for example in the form of a bribe, or it could be more intangible but nevertheless reflecting some form of “materialistic power dependency relation” (Suchman, 1995: 578). The second type of pragmatic legitimacy – influence – relates to legitimacy granted when there is an expectation of some sharing of the benefits of that legitimacy with those granting it. Examples could include the organization seeking legitimacy by adopting models of practice created by the organizations that grant legitimacy, or having personnel from granting organizations involved in the legitimated organization. The third form of pragmatic legitimacy occurs in situations where organizations have been granted positive human attributes. Dispositional legitimacy can be gained by institutions that have created a public image that suggests that the organization is honest, fair, decent and has our “best interest at heart” (Suchman, 1995: 578).

Moral legitimacy is granted because it is seen as the right thing to do – in society’s best interest, rather than the best interest of the person/entity making the judgement, as for pragmatic legitimacy. It generally involves an analysis of whether the organization is acting in a manner that will increase societal welfare, as defined by those granting legitimacy. Within this category, Suchman (1995) identifies four types: consequential, procedural, structural and personal. The legitimacy could be the consequences of the organization or its activity being seen as in society’s best interests. This type of legitimacy is often accompanied by a measurement and reporting system that can “objectively” quantify the positive consequence or benefit for society. Procedural moral legitimacy is achieved via adopting an acceptable method or procedure. In Western society, the scientific method is the easiest way to achieve this, and organizations will often seek to imitate the trappings of a scientific method to gain legitimacy. Often procedural legitimacy has a ritualistic element to it; being seen to adhere to the method or procedure is essential and often sufficient for legitimacy. Organizations that gain structural moral legitimacy do so because they are seen as valuable and worthy of support as a result of being located within a socially favoured category. The position in society makes the organization the right/best organization for the task or role; while the task undertaken by the institution could be considered essential for society, the legitimacy is generated by the organization’s position in society rather than its performance of that task. Many government organizations are likely to be legitimate because of their role in society. The last type of moral legitimation relates to the personal charisma of the leader or leaders of the entity: a belief that the leader(s) of the organization will act in the best interest of society. Essential for this form of legitimacy is that the leaders are trusted to do the right thing. This form of legitimacy is the most unstable of all forms and considered the easiest form for an organization to lose (Suchman, 1995).

The third type of legitimacy is based on cognition. Suchman divided cognitive legitimacy into two variants: comprehensibility and taken-for-granted. Legitimacy based on the comprehensibility of what the organization does requires that the organization’s account “must mesh both the with larger belief systems and with the experienced reality of the audience’s daily life” (Suchman, 1995: 582). To be legitimate, both the rhetoric of the organization and its actions need to be acceptable to the audience. The alternative approach for gaining cognitive legitimacy is through taken-for-granted legitimacy, which is based on a belief that without the organization things would not be right. The organization provides order to the unordered and thus makes conceptualizing the reality without the organization unthinkable. The existence of norms underpinning cognitive legitimacy can only be obtained by organizations with strong associations with other societal belief systems. Furthermore, they are the hardest to identify, disrupt and argue against, whilst also being the hardest to achieve (Suchman, 1995).

Suchman (1995) has been used in numerous studies in accounting literature across a wide range of areas including the legitimacy of accounting knowledge, accounting practices, the accounting profession and new auditing techniques. Durocher et al. (2007) used Suchman’s typology in developing an explanatory theory for the involvement of financial statements users in the accounting standard setting process. Combining Suchman’s typology with categories from other studies relating to organizational behaviour, they propose a model of how the users of financial statements participate in the accounting standard setting process. Georgiou and Jack (2011) used Suchman’s typology to understand the history of accounting measurement in relation to the legitimacy of historical cost, fair value accounting, and the use of mixed measurement bases. Using Suchman (1995) as a lens and explanatory framework they explain that “no accounting basis has become fully institutionalized to the exclusion of others” (Georgiou and Jack, 2011: 321). Carnegie and O’Connell’s (2012) use of Suchman (1995) relates to an examination of the responses of the two major Australian professional accounting organizations to crisis. The crisis called into question the legitimacy of the accounting profession, with Suchman’s typology being used to interpret behaviour by the accounting profession to maintain its legitimacy. O’Dwyer et al. (2011) uses Suchman to understand how new assurance statements for environmental and sustainability reporting gained legitimacy. This study introduces Suchman’s (1995) typology of organizational legitimacy to the literature on the history of public sector accounting, combining it with a typology of political legitimacy.

3.3. Political legitimacy

The government, in seeking to impose new auditing requirements on local government in the later part of the nineteenth century via the Parliament, could have imposed the requirements without any discussion or consultation and thereafter enforced penalties for non-compliance. However, in both cases in this study the state sought to engage with relevant sections of local government on the proposed laws prior to introducing them. The decision to consult was a decision to test the acceptability or the legitimacy of the state’s policy and proposed implementation of that policy in relation to audit practices. Barker (1990: 11) defines political legitimacy as: “The belief in the rightness of a state, in its authority to issue commands, so that those commands are obeyed not simply out of fear or self-interest, but because they are believed in some sense to have moral authority”. Political legitimacy is achieved because the polis accepts the state or their actions. At times the legitimacy of the state may have arisen from acceptance that the ruler has a divine or birth right to govern and impose laws on subjects. This form of legitimacy has given way to an array of more complex factors that influence when a state itself is legitimate, and when a law, regulation or action of the state is legitimate. Although states have a range of tools, penalties and enforcers to ensure compliance with laws and regulations, they are not needed or applied in most situations. Compliance increases as the state’s rules and regulation are perceived as being legitimate, thus reducing the need for any form of enforcement (Levi and Sacks, 2009).

Levi et al. (2009) identified two conditions for political legitimacy: trustworthiness and procedural justice. The trustworthiness is evaluated by the citizens and reflects their judgment or analysis of three aspects of the behaviour of the government: the intention or motivation of the leaders, the quality of the delivery of services, and the government’s administrative competency. The assessment of the motivation of the leaders consists of a response to the leaders’ charisma, past performances, and/or personal traits. The performance of the government relates to how well the state delivers the goods and services, it is expected to deliver, measured by perceived quality of the goods and services. The third element, administrative competency, is related to government performance but with a focus on how the goods and services are delivered in terms of process, honesty and compliance with the rules and regulation.

Procedural justice concerns the perceptions of fairness by the state. It encompasses a belief that the fair procedures will be followed in a predictable, trustworthy and even handed manner to all citizens, providing neither benefit nor harm to specific sections of community. While all aspects of legitimacy are about perceptions, negative perceptions about the procedural justice of a government or any of its actions will often override any positive perceptions held in relation to trustworthiness in the government (Levi et al., 2009).

Combining Power’s (2003) explanatory schema for the acceptance and/or rejection of proposed auditing practices and arrangements with both organizational and political legitimacy allows us to better understand how audit services in the public sector gained or failed to gain legitimacy. Insights from political legitimacy (Levi et al., 2009) and organizational legitimacy (Suchman, 1995) can assist in identifying what types of legitimacy are used or needed to gain legitimacy at each of Power’s (2003) categories of controversy, closure and credibility. The next section provides the background to New Zealand local government, with the following section applying the explanatory schema to the historical cases.

5.1. 1886 – Audit Office to be sole auditor of municipalities

The requirements for the auditing of municipalities in 1886 New Zealand are found in two separate pieces of legislation. The 1876 Municipal Corporations Act provided for the election of two auditors by the municipality’s electors. Eligibility for election as auditor was open to anyone, except bankrupts, criminals, those of unsound mind, elected councillors and the mayor, and those who had close financial connections with a council (employees and those with significant business dealings). The election of auditors was to be held annually, with remuneration for the elected auditors set annually by the council prior to their election (s. 95). Concurrently, the 1878 Public Revenues Act provided for the Audit Office to perform an audit on any borough that received a grant from central government, if required by the Governor (s. 33). The Act also specified that this was the only situation where the Audit Office was to audit a borough, unless another Act specifically required the Audit Office to undertake an audit of a borough.

This changed in 1886 when the Municipal Corporations Act 1886 made the Audit Office the auditor of all boroughs. The genesis of the proposal to change from elected auditors to the Audit Office can be traced back to 1881, when the CAG presented to Parliament a report titled a “Report on the Audit of Public Revenues” (Controller and Auditor-General, 1881). The report was the result of a study conducted by the CAG into financial management practices across the public sector in the Australian colonies. That report generated two concerns in New Zealand about the wisdom of using auditors elected from within the boroughs, citing concerns expressed in Australian colonies that used similar arrangements. The CAG considered that the existing system of electing auditors from local ratepayers relied on the “accident of finding individuals of sufficient public spirit and independent position to become prosecutors for the wrongs affecting all” (Controller and Auditor-General, 1881: 153). Municipal councils could only spend money when they had legislative authority to do so, and they could only engage in activities that were permitted by legislation. Prior to the 1886 legislation it was expected that the elected auditor or ratepayers would identify illegal expenditure and subsequently instigate legal proceedings against the elected councillors to recover illegal spending. The CAG believed that the likelihood of the elected auditors fulfilling this part of their role was low.

The second concern related to the use of central government grants. The CAG, in his 1881 report, illustrated his concern with reference to reported activities in one of the Australian colonies:

Where subsidies of public money are granted to local bodies the necessity of an independent audit becomes of additional importance. As an example of this, a case was mentioned to me by the Secretary to the Treasury in one of the colonies, of a Road Board which was said to have for years obtained the subsidy from the Government payable in proportion to the rates raised, and to have subsequently repaid the ratepayers their rates, and so secured the subsidy without the required local taxation. (Controller and Auditor-General, 1881: 153)

Once again the concern was the willingness or ability of elected auditors to faithfully undertake part of their role. This was highlighted especially where an auditor might benefit financially as a result of his position as a local ratepayer and/or resident should certain accounting/financial practices be undertaken.

A third concern regarding the competency of the elected auditors surfaced during debate on the proposed change. The parliamentary debate supported the position of the CAG that: “The present elective system was universally condemned (during the parliamentary debate) as a fallacy and a failure, and many illustrations were given of the manner in which the accounts of public bodies were audited by incompetent persons” (West Coast Times, 30 June 1886). Outside the parliament, most media shared similar concerns in their editorial comments regarding the competency of the elected auditors, with criticism of unspecified practices often being heard.

There is much to be said on either side (of the debate over elected versus Audit Office as auditors), and from the point of view of this district it matters little which way it is decided. There are some districts, though, in which Government auditors are absolutely necessary in the interests of common decency and honesty. (Poverty Bay Herald, 8 July 1886)

The first part of the controversy was a challenge to the legitimacy of the existing arrangements by raising the issue of trust. The status quo of using elected auditors was disturbed by the three-fold attack on their trustworthiness, started by the CAG and subsequently supported by various allies via the parliament and the media. This attack focused on the competency and performance of the elected auditors and included a critique of the possible motivation of some elected auditors. Therefore, all three of Levi et al.’s (2009) subtypes of trustworthiness for political legitimacy were present in creating the controversy. The challenge was not of an individual (elected) auditor or auditing per se, but of the arrangements imposed by the state on local government; it was a challenge to the existing arrangements that undermined their political legitimacy.

The move from a controversy that disturbed the status quo to closure where a new status quo is established can be seen in that the new requirements were accepted. The legitimacy needed to be either political or organizational, or both; at a political level the appointment of the Audit Office as auditor was required to be seen as a trustworthy act by the state, and at the organizational level the Audit Office and its practice needed to be seen as legitimate (in terms of pragmatic, moral or cognitive). In this case, the controversy against the status quo and the proposed new arrangements was a binary; the only two options considered were elected auditors or the Audit Office, and therefore some of the arguments for the loss of legitimacy of the elected auditors can be seen as the arguments for the Audit Office gaining legitimacy. The 1886 Bill that introduced the new provision making the Audit Office the auditor was passed in Parliament with significant majority support. The debate was not reported in Hansard, but media comments included that the debate was “animated” (Southland Times, 16 June 1886) and “long” (The Press, 16 June 1886). The media also reported that the Parliament expected the new provisions would solve the current problems of the lack of independence, expertise and competency of the elected auditors (West Coast Times, 30 June 1886). The rhetoric in favour of the change, as reported in the press, reflected both political and organizational legitimacy. The change of auditor to the Audit Office resulted in political legitimacy due to perceptions of its trustworthiness across all three of Levi et al.’s (2009) types: motivation performance and competency (see for example West Coast Times, 19 June 1886). The Audit Office and, in particular, its head, the CAG, had a reputation for robust audits of central government (Bohan, 1998), and it would have been expected that the Audit Office would provide the same level of robustness to the future auditing of the municipalities. Concurrently, there was support for the organization – the Audit Office – that reflected both cognitive and moral legitimacy. The choice of the Audit Office to be auditor included the logic that it was the obvious or best choice; no other options were put forward other than the by then discredited status quo of elected auditors. The Audit Office was perceived as the correct organizational arrangement for the audit of municipalities to ensure that their auditing was based on “common decency and honesty” (Poverty Bay Herald, 8 July 1886). As the existing central government auditor, the Audit Office’s position as a statutory auditor was well established; which would have undoubtedly aided the proposal becoming the new status quo.

Power’s (2003) third step involves the new requirements obtaining credibility. Credibility is gained by linking the arrangement, in this case auditing of municipalities, to the wider environment. The wider environment for this case was the relationship between the state that appointed the auditor and the municipalities, an often tense relationship. For the new arrangement to be legitimate it must be able to fit within the existing understanding of this relationship between central and local government. This credibility within the wider environment was achieved by the CAG re-defining the Audit Office’s role in relation to local government and their audits, and that gaining public support:

It may be objected that any interference by a central authority with the proceedings of local institutions, violates the principle of local self-government, and removes from the people themselves that responsibility for the due care of their own interests which constitutes its chief value. But, on the other hand, it should be remembered that the powers vested in local bodies are not general or arbitrary, but are defined by law, and are granted for specific purposes. So long as the administration of the local authorities within the sphere of the duties imposed on them is left uncontrolled, it can hardly be said to be an interference with local government, if provision is made for restraining them from exceeding those duties. (Controller and Auditor-General, 1881: 153)

Credibility was gained by aligning the Audit Office’s role with concerns from those that were likely to be opponents, namely those who wanted to avoid excessive central government involvement in local affairs. These fears were still very raw with the abolition of the provinces in the previous decade. The CAG allayed fears of inappropriate or unfair treatment of municipalities by the Audit Office; in Levi et al.’s (2009) political legitimacy framework he promised procedural justice. Local authorities would not be subject to any more interference than was appropriate as provided for in legislation. The issue of interference, procedural justice and trustworthiness resulting from new responsibilities or powers for the CAG and Audit Office becomes a more substantial issue in the following case.

5.2. 1891 and 1892 – the failure to pass audit legislation

In 1891 the CAG had a Bill introduced into Parliament that would give additional powers to the Audit Office, which in effect would be the CAG, in relation to local government financial management. These powers included:

A similar Bill was also introduced in 1892. Both of these Bills failed to be passed. Much of the content of the Bills had been foreshadowed in the CAG’s 1881 Report to Parliament, the report that he also used as the basis for the changes to the appointment of auditor in the previous case. As noted, that report included a strong emphasis on fraudulent and illegal activities and inappropriate accounting in local government. While sections in the report on the possible incompetency and untrustworthiness of elected auditors resulted in the Audit Office being made auditor of all municipalities in 1886, the new Bills focused on the trustworthiness of the elected councillors and council officials and mechanisms to punish illegal activity and grant to the Audit Office authority over the control of the local government financial management. The Report created the first part of a controversy, a disturbance of how people expect that local government politicians and officials may behave. The CAG raised the possibility that local government politicians and officials couldn’t be trusted and that the Audit Office should be given a stronger and enhanced mandate to take action against wayward councils and councillors. There were already provisions that dealt with these issues in the legislation, but the CAG wanted stronger enforcement and penalty provisions and for those powers to be given to his office. There was some support in the press for the additional powers provided for in the Bill, as some considered that the new provisions were “stringent … they are found to be needed” (Evening Post, 27 July 1891).

The response of the local government community (via Parliament) to the proposed legislation was forceful and direct. The majority of speakers against the Bill were representatives of electorates in cities and large boroughs. The most forceful speech against the first Bill was by Henry Fish, member for Dunedin City, who was acknowledged during the debate “as an authority on municipal matters”. In a style he was noted for (Sinclair, 1993), Fish led the attack on the Bill and the CAG in the following words:

This Bill appears to be a Bill of the most monstrous description ever presented to the House. I feel certain the Premier has never read the Bill; if he has read it he has not profited by the reading. It is not the Premier’s Bill; it is the Auditor-General’s Bill; he has drafted every line of it, and every line bristles with tyranny and autocracy of the most disgusting nature. Knowing that gentleman, however, as well as I do, I am not surprised that he has given us a Bill of this kind. I have no hesitation in saying, especially so far as Municipal Corporations are concerned, that the Bill is framed effectually for no other purpose than to hamper the finance, irritate the bookkeeping, and utterly demoralise the proper carrying-on of municipal functions. (NZPD, 1891: 313)

Fish criticized various parts of the Bill and the person of the CAG, objecting to both in very strong terms. He saw such legislation (and the likely interpretation of it by the current CAG) as constraining the activity of local authorities, and claimed that local government legislation should be used to “extend, and not to cramp, the powers of local bodies”. Other speakers were less damning of the Bill, but even those indicating support did not give it without some qualification: “That there is reason for a more strict audit than we have had in the past none of us, I think, will deny; but I hold at the same time, that the present Bill is too sweeping” (NZPD, 1891: 315).

The 1891 Bill failed to become law because the CAG had failed, in terms of Power’s (2003) framework, to gather sufficiently influential allies around the disturbance. It was a failure to gain political legitimacy. The proposed state action failed to gain legitimacy, partly at least, as a response to leadership motivation of the CAG (Levi et al., 2009), including concerns regarding how the Bill would be applied if enacted. For procedural justice, a sense of fairness is required and this “relies upon the beliefs that government officials follow a set of fair procedures and that they do so in a predictable and trustworthy fashion” (Levi et al., 2009: 360). In this case, local government and their parliamentary supporters did not support the new proposals because they did not believe that local government would receive procedural justice from the State’s officer responsible for applying the provisions of the legislation, the CAG.

The following year a new Bill was introduced, which was considered to be less draconian. The 1892 Bill went through the parliamentary system with significantly less agitation. It appears that there was the possibility of gathering sufficient allies for the Bill to pass and that a new status quo would be achieved, but some members of the local government community were still against clauses of the Bill. For example, the Secretary of the Wellington Harbour Board suggested that the penalties were too severe and a disincentive to people to stand for election on boards and councils:

Businessmen give their time and abilities gratuitously, to the service of the public, on local bodies, and so long as they act in good faith they ought not to be subjected to the possible infliction of fines or of surcharges or have the onus cast on them of moving the Supreme Court for remission thereof. (LE 1 1892/14)

Similar views were expressed by local authorities. For example, the Christchurch City Council was reported as saying that the measures in the Bill were “arbitrary, and calculated to deter gentlemen from coming forward to serve the city” (The Press, 5 April 1892). While a controversy was created, the 1892 Bill lapsed because significant or influential parts of the local government community were not prepared to renormalize practice along the lines of the Bill; in Power’s (2003) terms, closure was not obtained. Both the allies and opponents of the second Bill were not willing to see the provisions in the Bill become part of the arrangements for local government finance. Like the Bill the previous year, this was a failure to obtain political legitimacy, specifically a concern with not obtaining procedural justice from the enforcer of the new powers.

The major obstacle for the passing of both bills was the CAG himself, not the content of bills. The CAG, James Edward FitzGerald, was not universally admired. A politician before late in life becoming CAG, he was much more at home in “the cut and thrust of public controversy” (Bohan, 1998: 305) than the neutrality of his role as CAG. It is possible that a different man could have negotiated with both allies and opponents to gain closure and then credibility for this proposal. FitzGerald’s character in the CAG role created problems for the proposals gaining political legitimacy, in terms of perceptions about both the trustworthiness and procedural fairness of the government actions (Levi et al., 2009). In the earlier case, Fitzgerald was also the CAG but was not an obstacle to the change from elected auditors to the Audit Office as the auditor of municipalities. The perception of the trustworthiness of how the enforcer of two different pieces of legislations would act in each situation was quite different. The CAG and the Audit Office were perceived to be a trustworthy replacement of the elected auditors in relation to all three of Levi et al.’s (2009) types: motivation, performance and competency. Local government’s perception of the CAG as the State’s officer responsible for the proposed new powers in this second case was that he wasn’t trustworthy.