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This 2002 Policy Is Still Affecting Nonprofits

Calculator sitting on top of financial statementsFrom the Green New Deal to a 70 percent top tax rate, the 116th Congress is discussing policies with far-reaching potential. But what about reforms from more than a decade ago? New research from the University of Chicago Booth School of Business uses GuideStar data to explore the unintended consequences for nonprofits of corporate finance reform put in place in 2002.

New research shows that nonprofit organizations are not immune to government regulations directed at publicly traded companies. The researchers, including Yale University’s Raphael Duguay; Michael Minnis of the University of Chicago Booth School of Business; and MIT’s Andrew Sutherland, examined how the passage of the 2002 Sarbanes Oxley Act (SOX) affected nonprofit organizations. Their research—which was supported by Chicago Booth’s Rustandy Center for Social Sector Innovation—finds evidence that SOX led to higher auditing fees for nonprofits, despite the fact that the legislation was intended to regulate public corporations and did not target nonprofits.

What is SOX?

Sarbanes Oxley was passed in response to a series of scandals involving major corporations, including Enron and WorldCom. The eventual collapse of these firms cost investors billions of dollars and shook investor confidence. SOX introduced new regulations on the accounting and auditing procedures of public corporations. Among these was the requirement that auditors test internal controls, which are procedures that corporations put in place to prevent fraudulent reporting and the misuse of funds.

What SOX meant for nonprofits

While the SOX regulations may have helped to quell bad corporate behavior, nonprofits were left with mixed results. The researchers, using GuideStar data on thousands of nonprofits, found that the stricter reporting requirements affected nonprofits because both nonprofits and public companies accessed the same pool of accounting firms. The higher demand for auditing services caused by SOX raised the audit fees for public, private, and nonprofit organizations alike. The increase in demand for audit services was not met with an immediate increase in the availability of certified public accountants (CPAs). As the demand for auditors increased, so did the price for their services, and some firms responded by moving resources from their nonprofit clients to their corporate clients to meet the higher workload.

Now what?

There might be some good news, however. The researchers found that the increase in fees was exacerbated when the auditors were busier, such as at the end of the year for example. Nonprofits may be able to benefit from this knowledge by timing their audits accordingly.

Researchers also found that the structure of the audit market itself changed after the passage of SOX. The extra requirements may have contributed to a division in the audit market between auditors that focus on public companies and those that focus on private companies and nonprofits. The extra requirements appear to have caused many of the smaller auditing firms to leave the market for public companies and focus instead on smaller clients like nonprofits.

While it remains to be seen if the separation between the auditing market for nonprofits and public corporations will continue, the research shows that both nonprofit leaders and regulators should pay attention to possible spillover effects of laws aimed at public corporations. In the meantime, nonprofit leaders who have had to switch auditors or who have seen their auditing fees rise over the past decade will know their experience might have been shared by thousands of other nonprofits.

This post was provided by The Rustandy Center for Social Sector Innovation at the University of Chicago Booth School of Business.

Topics: Nonprofits and Sarbanes Oxley Act Nonprofit Financial Audits