When Employees Go to Court: Audit Office Labor Market Reputation and Audit Quality

• In Event: Auditor Labor Markets II

Abstract

I investigate whether a loss of labor market reputation adversely affects audit firms' ability to attract high-quality employees, which, in turn, could impede their ability to provide high-quality audits. Labor market reputation captures potential employees' perceptions of a firm and its desirability as an employer. Using employment-related lawsuits that plausibly erode an audit office’s reputation in the labor market and a novel dataset of individual auditor profiles, I find that employee lawsuits hurt the sued audit office’s ability to attract talent. Specifically, I find that employment-related lawsuits lead to a decrease in the likelihood of an audit office attracting employees who graduated from top-ranked universities or accounting programs or have more work experience. The adverse effect of employee lawsuits is more salient when hiring employees at a higher position and is mitigated when an audit office pays higher wages or has greater market power in the local area. I also document a deterioration in audit quality, as measured by financial restatement propensity, following the lawsuits. Overall, this evidence highlights the importance of audit office reputation in the labor market and provides practical implications for audit firms' employee treatment and reputation management in the labor market.

Author

• Jade Huayu Chen, University of Arizona