Regulatory Spillovers in Common Audit Markets

Abstract

We find that Sarbanes-Oxley (SOX) had two significant effects on the audit market for nonpublic entities. The first short-run effect stems from inelastic labor supply coupled with an audit demand shock from public companies. As a result, private companies reduced their use of attested financial reports in bank financing by 12%, and audit fee increases for nonprofit organizations (NPOs) more than doubled. The second long-run effect was a transformation in the audit supply structure. After SOX, NPOs were less likely to match with auditors most exposed to public companies, while auditors increasingly specialized their offices based on client type. Audit market concentration for NPOs dropped by more than half within five years of SOX and remained at this level through the end of our sample in 2013, while the number of suppliers increased by 26%. Our results demonstrate how regulation directed at public firms generates economically important spillovers for nonpublic entities.

Keywords: Sarbanes-Oxley, securities regulation, auditing, market structure, accounting, private firms, non-profits, labor economics

JEL Classification: H83, M12, M21, M41, M48, M49