Auditor Specialization in the Nonprofit Sector

While Big 4 has been an effective audit quality measure in many industries, it has had mixed results in the nonprofit sector. This paper considers the use of industry specialization as an audit quality measure and investigates the determinants and effects of selecting an industry specialist on nonprofit organizations in the United States. Our results indicate that the determinants and consequences of selecting an industry specialist auditor vary significantly from those associated with Big 4 audit firm selection but are similar to those of industry specialist auditor selection in the public company sector. We find industry specialist auditor choice is associated with higher governance quality (higher governance index, larger boards, and more independent boards) and higher financial risk, indicating auditor selection is a complement in the overall governance system of nonprofit organizations. Moreover, specialist auditors have a shorter audit report lag than both non-specialist auditors and Big 4 auditors, an indicator of higher auditor reporting quality. Nonprofits audited by specialist auditors also see a future increase in direct donations and a decrease in government grants for funding their operations. We conclude that specialist auditors help nonprofits diversify their revenue streams, important as it helps strengthen their financial position, stability and viability.