The credibility of audit quality signaling among small audit firms in the not-for-profit audit market

• In Event: Not-For-Profit Audit

Abstract

Many small public accounting firms state that they register voluntarily with the PCAOB to signal high audit quality to current and prospective non-SEC issuer clients. Using a large sample of not-for-profits (NFPs) subject to the Single Audit Act, we investigate the credibility of this signal by testing for audit quality differences among voluntarily-registered auditors, auditors that are not registered with the PCAOB, and auditors who are registered and triennially inspected by the PCAOB. We find no differences in audit quality between voluntarily registered and nonregistered firms. We also find that voluntarily registered firms conduct lower quality audits than triennially inspected auditors. However, audit firms increase their market share in the NFP sector in the two years following voluntary registration, suggesting that at least some clients perceive the signal as credible. Overall, our results suggest that the practice of voluntary registration could lead to an expectations gap, suboptimal auditor selection decisions, and inefficiencies in the audit market for non-SEC issuer clients. These results have implications for the regulation and self-regulation of the auditing profession and contribute to the literature on the regulation of small audit firms and audit quality in the not-for-profit sector.

Authors

• Anne Margaret Thompson, University of Illinois-Urbana-Champaign

• Devin Williams, University of Illinois-Urbana-Champaign