When Employees Go to Court: Audit Office Labor Market Reputation and Audit Quality
Abstract: I investigate whether a loss of labor market reputation adversely affects audit offices’ ability to attract high-quality auditors, which, in turn, could impede their ability to provide high-quality audits. Labor market reputation captures prospective employees’ perceptions of a firm and its desirability as an employer. Using employment-related lawsuits that plausibly erode an audit office’s labor market reputation, and a novel dataset of individual auditor resumes, I find that employee lawsuits harm the sued audit office’s ability to attract talent. Specifically, I find that employee lawsuits lead to a decrease in the likelihood of an audit office attracting auditors who graduated from top-ranked universities or accounting programs, or those with more work experience. The adverse effect of employee lawsuits is more salient when hiring auditors at senior positions and is mitigated when an audit office is larger or pays higher wages in the local area. Further, following the lawsuits, I find a deterioration in audit quality, as measured by financial restatement propensity. Finally, I use mediation analysis to show that an office’s inability to attract quality applicants is one channel through which reputation affects audit quality. Overall, my study highlights the importance of human capital management and reputation building in enhancing audit offices’ position in a competitive labor market.
Air Pollution and Audit Quality within the United States
Coauthored with: Paul Michas, Dan Russomanno, and Wenzi Zhuang
Abstract: We examine whether PM2.5 air pollution impacts audit quality within the United States. We find a positive association between air pollution at an audit client’s location, measured during the year-end audit window when auditors are likely to travel to their client’s headquarters, and the likelihood of a non-reliance restatement. Further, we examine a sub-sample where auditors travel more than 100 miles to their audit client’s location and, therefore, are more likely to be exposed to a difference in pollution levels relative to their auditor’s home office. Using this sub-sample, we find restatement likelihood is increasing in this difference in pollution at the audit client’s site, which is incremental to any pollution effect attributable to the auditor’s home office. Moreover, we use wildfires as an instrumental variable within a two-stage estimation method and find the predicted unbiased estimates of air pollution are positively associated with restatement likelihood. Finally, we find pollution incrementally impedes audit quality when auditing a subset of firms we measure as being more challenging or difficult to audit. Taken together, our findings are consistent with air pollution impeding audit quality.
The Impact of National Office Governance on Audit Quality
Coauthored with: Preeti Choudhary
Abstract: We investigate whether national office governance is associated with audit quality provided by local audit offices. We proxy for national office governance using two measures of geographical proximity, distance and frequent, direct airline routes between a practice office and the national office of the firm, where the latter introduces exogenous variation. We predict and find closer proximity strengthens national office governance through more monitoring and knowledge transfer, resulting in better audit quality, captured by lower propensity of restatements. Cross-sectional analyses confirm that the relation varies with national office’s sensitivity to costs. Finally, we find that smaller audit firms benefit less from national office governance, consistent with theory that suggests smaller partnership structures have less moral hazard costs and less knowledge transfer benefits from national office governance. Collectively, our results help to explain one avenue that develops audit quality within audit firms.
Does Verification of Internal Control over Financial Reporting Affect Voluntary Disclosure?
Coauthored with: Preeti Choudhary, Aditi Khatri, and Shyam Sunder
Abstract: We investigate whether firms and investors view the presence of the audit of internal controls over financial reporting (ICFR verification) as enhancing the likelihood and credibility of voluntary disclosures. We do so by exploiting a recent amendment to Smaller Reporting Company Regulatory Relief and Simplification in 2018 that generated a sample of firms that are both exempt from mandatorily disclosing certain items in their periodic filings (i.e., move to a voluntary disclosure regime) and are subject to ICFR verification. By comparing this sample to firms that are not subject to ICFR verification but also voluntary disclosers, we find that firms subject to ICFR verification are more likely to voluntarily disclose exempt items. Further, a difference-in-differences design reveals that investors on average view ICFR verification as a substitute for loss of commitment when firms move from mandatory to voluntary disclosure regime but continue to disclose. However, investors do not view ICFR verification as a substitute for loss of information for firms that reduce disclosure, rather they penalize them. Taken together, our findings contribute to an ongoing debate about the costs and benefits of ICFR verification.