Post-SOX downward auditor switches and their impacts on the nonprofit audit market

Abstract

This study examines the extent of downward auditor switches from Big 4 audit firms by nonprofit organizations (NPOs) after enactment of the Sarbanes-Oxley Act (SOX). Although SOX provisions do not directly apply to nonprofit organizations, capacity constraints and client realignments due to SOX may have reduced the Big 4 presence in the nonprofit audit market. We find that downward switches from a Big 4 firm increased in the post-SOX period. Universities and colleges are more likely than other NPOs to have downward switches from a Big 4 audit firm in the post-SOX period compared to the pre-SOX period. These results suggest that SOX had differential impacts on NPOs depending on the nature of the organization. Risky NPOs, as indicated by the existence of internal control deficiencies, were more likely to have downward auditor switches. NPOs are more likely to choose a non-Big 4 specialist following a downward switch compared to other NPOs with non-Big 4 auditors, consistent with higher demand for audit quality by these organizations. We do not find significant evidence that downward switches for these organizations are associated with decreases in subsequent donations. However, we find that downward switchers are associated with increases in material weaknesses in internal control.