The Effect of a Financial Statement Audit on Governance Practices

Abstract

I investigate the effects of a financial statement audit on the governance practices of organizations. I find that obtaining an audit causes organizations to implement governance mechanisms such as conflict-of-interest policies, whistleblower policies, and formal approval of the CEO’s compensation. I also find that audits curtail managers’ ability to extract private benefits as evidenced by a reduction in nepotism and the CEO-to-employee pay ratio. To perform my analyses, I turn to the nonprofit setting because it offers plausibly exogenous variation in audits, and standardized disclosures about governance practices. Specifically, I rely on a regression-discontinuity design based on state-level regulatory thresholds that dictate which organizations are legally required to obtain an audit.

Keywords: auditing, governance, real effects, nonprofit organizations

JEL Classification: M42, G34, M48, L31