City-Level Human Capital and Audit Markets

• In Event: Differences Across Audit Offices
  In Paper Session: Differences across Audit Offices

Abstract

This study investigates how human capital in a specific city affects the audit market in that city. Human capital is generally measured as the average educational level in a city, and we argue that this will affect the quality of labor in the local audit market. We predict and find evidence that audit quality is positively associated with the level of human capital in an audit office’s local labor market, and that this association is stronger for smaller (i.e. non-Big 4) audit firms than for larger audit firms, which are less reliant on local labor markets. All else equal, public companies are more likely to choose a non-Big4 auditor when the level of human capital in the audit office’s local labor market is high. Further, audit quality, as measured by clients’ abnormal accruals, total working capital accruals, and accrual estimation errors, improves as human capital increases and this relationship is stronger for non-Big 4 auditors. Finally, we show the audit fees earned by non-Big 4 audit firms, but not Big 4 audit firms, increase in the level of local human capital. Together, these results suggest that small auditors’ greater reliance on local labor markets affects their ability to compete in the public company audit market.

Authors

• Matthew James Beck, University of Missouri–Columbia

• Jere R Francis, University of Missouri–Columbia

• Joshua Gunn, University of Missouri–Columbia