Abstract
This study examines the relation between audit personnel salaries and office-level audit quality. We measure audit personnel salaries at the associate, senior, and manager ranks for Big 4 audit offices from 2004 to 2013, using unique individual-auditor-level data obtained from the U.S. Department of Labor. We find that offices that pay lower salaries have a higher percentage of clients that experience restatements. In related analyses, we also find lower levels of audit quality when audit employees are paid less, relative to other lines of service in accounting firms. Finally, we document positive and significant associations between salary and fees, suggesting that audit offices pass some of the cost of higher labor onto their clients. Overall, our findings provide important initial evidence on the role of audit salary and its relation to audit quality and audit fees.
Similar content being viewed by others
Notes
For additional theoretical studies examining the efficiency wage theory, see Malcomson (1981), Akerlof and Yellen (1990), Yellen (1995), Fehr and Gächter (2000), and Chen and Sandino (2012). For additional empirical studies providing evidence consistent with the efficiency wage theory, see Levine (1993), Cappelli and Chauvin (1991), Fehr et al. (1993), Marti (1997), Fehr and Falk (1999), Hannan et al. (2002), Hannan (2005), Stevens and Thevaranjan (2010), and Chen and Sandino (2012).
The concern that uncompetitive salaries steer potential accountants into more lucrative careers is not new. For example, in 2000, it was noted that one reason why the quantity and quality of accounting students was reported to be falling was due to “starting salaries for accounting majors not increasing at the same rate as for other business majors” (Albrecht and Sack 2000).
The vast majority of our sample includes H-1B temporary, non-immigrant visa applications. The data also includes a small number of permanent worker visa applications. We also include in our definition of H-1B visa applications the labor condition application, which is filed by the employer as part of the visa application process. We refer to all of these applications as H-1B visa applications throughout the remainder of the study.
We find that interquartile shifts in salaries result in lower misstatement rates of 7.23, 6.84, and 14.26%, relative to the subsample means for the associate, senior, and manager analyses, respectively.
See, for example, http://www.big4guide.net/who-are-the-big-4/salaries/.
We find that interquartile shifts in the wage gap are associated with misstatement rates that are 5.92, 5.94, and 12.3% lower, relative to the subsample means for the associate, senior, and manager analyses, respectively.
In a 2012 speech about the state of the audit profession, PCAOB board member Jay Hanson expressed concerns that PCAOB inspections and standards may have affected the work-life of auditors, stating “one result of our activities … is that the best and brightest auditors become frustrated and leave the profession (Hanson 2012).” Later in 2013, Hanson, in a speech at the Baruch College’s 2013 Financial Reporting Conference, further stated: “One exceptionally troubling issue that I sense is getting worse is the sheer number of hours that audit teams are expected to work. … How do you function if you are working 16 h per day on a continual basis? … If audit teams are working excessive hours, there is a problem (Hanson 2013).”
Messier et al. (2008) finds evidence that partners tend to overestimate the ability of lower level personnel to detect fraud and other complex errors. While understanding partner compensation is important, it is also important to understand the relationship between audit personnel compensation and audit quality at the associate, senior, and manager level, given they play an important role in the external audit and that partners tend to over-estimate their ability.
We focus on the overall pay of an audit office for a given audit firm. However, within an office, pay disparity may affect audit outcomes. It may be the case that generous partner compensation motivates staff, for example, to work hard and achieve partner, or it may be a demotivating factor. The distribution of pay across ranks within an auditor office is beyond the scope of this paper.
There are many different types of visas, depending on whether the applicant is an immigrant or a non-immigrant, the relationship of the applicant to a U.S. citizen, the country of origin of the applicant, and the type of work being performed. An H-1B visa is for an alien in a “specialty occupation,” where a specialty occupation is one that, among other things, may require “attainment of a bachelor’s or higher degree in the specific specialty (or its equivalent) as a minimum for entry into the occupation in the United States (Immigration and Nationality Act 214(h)(i)(1)(B)),” which will generally include financial statement auditors.
One might also consider controlling for or adjusting the dependent variable for the “prevailing wage” that firms are required to provide on their LCA they file in the H-1B filing process. Firms report a prevailing wage, which is the average wage for similar work in the area, in their LCA to demonstrate that they are complying with the law that requires immigrants receive wages at least equivalent to domestic workers. Given firm incentives to qualify workers as sufficiently paid, it is not clear what biases may exist in the prevailing wage value. Instead of using this potentially biased value, in some tests, we control for MSA-year fixed effects, which controls for the average wage that dominates in that geographic region in the year for Big 4 audits (as opposed to the prevailing wage, which will possibly take into account other types of auditors at other types of accounting firms).
Some H-1B applicants graduate from these three universities and will in fact be included in our sample. But, in these three universities, the majority of graduates are domestic students who will not be H-1B applicants. The three universities that gave us graduate salary data did not provide us with the visa status of their graduates.
This value is invariably affected by the fact that, as we progress to more experienced job positions, we have fewer visa applications, both because there are fewer people in these positions and because people who advance may achieve permanent status and not need to file for a visa. These data also represent our oversampling of larger cities, where the cost of living is higher (assuming the cost of living affects salaries, which we verify in Section 4).
As indicated previously, since our H-1B visa data is most available for lower level employees, there is data available for fewer states as the rank of the salary increases.
See, for example, https://www.census.gov/construction/nrs/pdf/uspricemon.pdf.
We also alleviate this concern by dropping the most populous city, New York, and find our results are robust. Another way to understand this concern is that how the analysis is currently conducted is equivalent to value weighting the cities by the number of visas (which, if visa applications are constant as a percentage of the population across cities, reflects the economic reality of the importance of those cities). Condensing each city down to a single observation per firm/year is equivalent to equal weighting observations, so that the Boise office of EY can influence the estimates as much as the New York City office can.
All three programs rank in the top 15 in the Public Accounting Report ranking of master of accounting programs in 2015.
Discretionary accruals is the absolute value of the firm-year residual from a regression of working capital accruals using a modified Jones model that controls for performance, growth, lagged accruals, and nonlinear effects of positive and negative cash flows from operations, estimated for each industry-year with at least 20 observations.
References
Akerlof, G. A. (1984). Gift exchange and efficiency-wage theory: four views. The American Economic Review, 74(2), 79–83.
Akerlof, G. A., & Yellen, J. L. (1986). Efficiency wage models of the labor market. Cambridge: Cambridge University Press.
Akerlof, G. A., & Yellen, J. L. (1990). The fair wage-effort hypothesis and unemployment. The Quarterly Journal of Economics, 105(2), 255–283.
Albrecht, W. S., & Sack, R. J. (2000) Accounting education: Charting the course through a perilous future. American Accounting Association.
Almer, E. D., Higgs, J. L., & Hooks, K. L. (2005). A theoretical framework of the relationship between public accounting firms and their auditors. Behavioral Research in Accounting, 17(1), 1–22.
Aobdia, D. (2016) The validity of publicly available measures of audit quality. Evidence from the PCAOB data. Working Paper.
Aobdia, D. (2017). The impact of the PCAOB individual engagement inspection process - Preliminary Evidence. Forthcoming, The Accounting Review.
Aobdia, D., Srivastava, A. & Wang, E. (2017). Are immigrants complements or substitutes? Evidence from the Audit Industry. Management Science Forthcoming.
Bamber, L. S., Jiang, J., & Wang, I. Y. (2010). What’s my style? The influence of top managers on voluntary corporate financial disclosure. The Accounting Review, 85(4), 1131–1162.
Barrios, J. M. (2017) Occupational licensing and accountant quality: Evidence from Linkedin. Working paper.
Beck, M., Francis, J., & Gunn. J. (2017) Public company audits and city-specific labor characteristics. Contemporary Accounting Research Forthcoming.
Bertrand, M., & Schoar, A. (2003). Managing with style: the effect of managers on firm policies. The Quarterly Journal of Economics, 118(4), 1169–1208.
Bianchi, P. (2018) Auditors’ joint engagements and audit quality: Evidence from Italian private companies. Contemporary Accounting Research Forthcoming.
Biddle, G. C., Hilary, G., & Verdi, R. S. (2009). How does financial reporting quality relate to investment efficiency? Journal of Accounting and Economics, 48(2–3), 112–131.
Blankley, A. I., Hurtt, D. N., & MacGregor, J. E. (2012). Abnormal audit fees and restatements. Auditing: A Journal of Practice & Theory, 31(1), 79–96.
Boland, C. M., Bronson, S. N., & Hogan, C. E. (2015). Accelerated filing deadlines, internal controls, and financial statement quality: the case of originating misstatements. Accounting Horizons, 29(3), 551–575.
Bonner, S. E., & Lewis, B. L. (1990). Determinants of auditor expertise. Journal of Accounting Research, 28, 1–20.
Bronson, S. N., Hogan, C. E., Johnson, M. F., & Ramesh, K. (2011). The unintended consequences of PCAOB auditing standard nos. 2 and 3 on the reliability of preliminary earnings releases. Journal of Accounting and Economics, 51(1), 95–114.
Cappelli, P., & Chauvin, K. (1991). An interplant test of the efficiency wage hypothesis. The Quarterly Journal of Economics, 106(3), 769–787.
Carcello, J. V., Hermanson, D. R., & Huss, H. F. (2000). Going concern opinions: the effects of partner compensation plans and client size. Auditing: A Journal of Practice & Theory, 19(1), 67–77.
Carey, P., & Simnett, R. (2006). Audit partner tenure and audit quality. The Accounting Review, 81(3), 653–676.
Chen, C. X., & Sandino, T. (2012). Can wages buy honesty? The relationship between relative wages and employee theft. Journal of Accounting Research, 50(4), 967–1000.
Choi, J.-H., Kim, C., Kim, J.-B., & Zang, Y. (2010). Audit office size, audit quality, and audit pricing. Auditing: A Journal of Practice & Theory, 29(1), 73–97.
Choudhary, P., Merkley, K. J. & Schipper, K. (2016) Qualitative characteristics of financial reporting errors deemed immaterial by managers. Working Paper.
Christensen, B. E., Glover, S. M., Omer, T. C., & Shelley, M. K. (2015) Understanding audit quality: insights from audit professionals and investors. Forthcoming, Contemporary Accounting Research.
DeAngelo, L. E. (1981). Auditor size and audit quality. Journal of Accounting and Economics, 3(3), 183–199.
DeFond, M., & Zhang, J. (2014). A review of archival auditing research. Journal of Accounting and Economics, 58(2–3), 275–326.
Dyreng, S. D., Hanlon, M., & Maydew, E. L. (2010). The effects of executives on corporate tax avoidance. The Accounting Review, 85(4), 1163–1189.
Ettredge, M. L., Bedard, J. C., & Johnstone, K. M. (2008). Empirical tests of audit budget dynamics. Behavioral Research in Accounting, 20(2), 1–18.
Ettredge, M., Heintz, J., Li, C., & Scholz, S. (2011). Auditor realignments accompanying implementation of SOX 404 ICFR reporting requirements. Accounting Horizons, 25(1), 17–39.
EY. (2016) EY’s Paid Parental Leave Policy in US Increased To 16 Weeks for New Moms and Dads. PR Newswire, April 13.
Fehr, E., & Falk, A. (1999). Wage rigidity in a competitive incomplete contract market. Journal of Political Economy, 107(1), 106–134.
Fehr, E., & Gächter, S. (2000). Fairness and retaliation: the economics of reciprocity. The Journal of Economic Perspectives, 14(3), 159–181.
Fehr, E., Kirchsteiger, G., & Riedl, A. (1993). Does fairness prevent market clearing? An experimental investigation. The Quarterly Journal of Economics, 108(2), 437–459.
Ferguson, A., Francis, J. R., & Stokes, D. J. (2003). The effects of firm-wide and office-level industry expertise on audit pricing. The Accounting Review, 78(2), 429–448.
Files, R., Sharp, N. Y., & Thompson, A. M. (2013). Empirical evidence on repeat restatements. Accounting Horizons, 28(1), 93–123.
France, J. (2015) Office Space: EY’s Workplace of the Future plays musical chairs—with more than chairs. Columbus CEO, August 17.
Francis, J. R. (2011). A framework for understanding and researching audit quality. Auditing: A Journal of Practice & Theory, 30(2), 125–152.
Francis, J. R., & Yu, M. D. (2009). Big 4 office size and audit quality. The Accounting Review, 84(5), 1521–1552.
Ghosh, A., & Moon, D. (2005). Auditor tenure and perceptions of audit quality. The Accounting Review, 80(2), 585–612.
Hannan, R. L. (2005). The combined effect of wages and firm profit on employee effort. The Accounting Review, 80(1), 167–188.
Hannan, R. L., Kagel, J. H., & Moser, D. V. (2002). Partial gift exchange in an experimental labor market: impact of subject population differences, productivity differences, and effort requests on behavior. Journal of Labor Economics, 20(4), 923–951.
Hanson, J. D. (2012) Reflections on the State of the Audit Profession presented at the American Accounting Association, Auditing Section, Mid-Year Meeting, January 23, Savannah, GA.
Hanson, J. D. (2013) Keynote Address at Baruch College 12th Annual Financial Reporting Conference May 2.
Hay, D. C., Knechel, W. R., & Wong, N. (2006). Audit fees: a meta-analysis of the effect of supply and demand attributes. Contemporary Accounting Research, 23(1), 141–191.
IFIAR (2014) Current trends in the audit industry. International Forum of Independent Audit Regulators.
Knechel, W. R., Niemi, L., & Zerni, M. (2013). Empirical evidence on the implicit determinants of compensation in big 4 audit partnerships. Journal of Accounting Research, 51(2), 349–387.
Krishnan, J., & Yang, J. S. (2009). Recent trends in audit report and earnings announcement lags. Accounting Horizons, 23(3), 265–288.
Laux, C., & Leuz, C. (2009). The crisis of fair-value accounting: making sense of the recent debate. Accounting, Organizations and Society, 34(6–7), 826–834.
Levine, D. I. (1993). What do wages buy? Administrative Science Quarterly, 38(3), 462–483.
Libby, R., Bloomfield, R., & Nelson, M. W. (2002). Experimental research in financial accounting. Accounting, Organizations and Society, 27(8), 775–810.
Malcomson, J. M. (1981). Unemployment and the efficiency wage hypothesis. The Economic Journal, 91(364), 848–866.
Marti, C. (1997). Efficiency wages: Combining the shirking and turnover cost models. Economics Letters, 57(3), 327–330.
McGinn, D. (2015) This is the perfect hotel for business travelers, but you’ll never stay there. Bloomberg, March 25.
Messier, W. F., Owhoso, V., & Rakovskit, C. (2008). Can audit partners predict subordinates' ability to detect errors? Journal of Accounting Research, 46(5), 1241–1264.
Minnis, M. (2011). The value of financial statement verification in debt financing: evidence from private U.S. firms. Journal of Accounting Research, 49(2), 457–506.
Nelson, M., & Tan, H. (2005). Judgment and decision making research in auditing: a task, person, and interpersonal interaction perspective. Auditing: A Journal of Practice & Theory, 24(1), 41–71.
Palmrose, Z.-V., Richardson, V. J., & Scholz, S. (2004). Determinants of market reactions to restatement announcements. Journal of Accounting and Economics, 37(1), 59–89.
Persellin, J., Schmidt, J. J., & Wilkins, M. S. (2015) Auditor perceptions of audit workloads, audit quality, and the auditing profession. Working Paper.
PwC. (2017) Our focus on audit quality. 1–29. Available at: https://www.pwc.com/us/en/audit-assurance-services/assets/pwc-our-focus-on-audit-quality-2017.pdf
Reason, T. (2010) Auditing Your Auditor. CFO April: 36–42.
Reichelt, K. J., & Wang, D. (2010), National and office‐specific measures of auditor industry expertise and effects on audit quality. Journal of Accounting Research, 48(3), 647–686.
Reynolds, J. K., & Francis, J. R. (2000). Does size matter? The influence of large clients on office-level auditor reporting decisions. Journal of Accounting and Economics, 30(3), 375–400.
Schroeder, J. H., & Shepardson, M. L. (2016). Do SOX 404 control audits and management assessments improve overall internal control system quality? The Accounting Review, 91(5), 1513–1541.
Shapiro, C., & Stiglitz, J. E. (1984). Equilibrium unemployment as a worker discipline device. The American Economic Review, 74(3), 433–444.
Shumway, T. (2001). Forecasting bankruptcy more accurately: a simple hazard model. The Journal of Business, 74(1), 101–124.
Skinner, D. J., & Srinivasan, S. (2012). Audit quality and auditor reputation: evidence from Japan. The Accounting Review, 87(5), 1737–1765.
Stevens, D. E., & Thevaranjan, A. (2010). A moral solution to the moral hazard problem. Accounting, Organizations and Society, 35(1), 125–139.
Tysiac, K. (2015) More evidence of accelerating growth in accounting and finance salaries. Journal of Accountancy, September 9.
Venkataraman, R., Weber, J. P., & Willenborg, M. (2008). Litigation risk, audit quality, and audit fees: evidence from initial public offerings. The Accounting Review, 83(5), 1315–1345.
Weintraub, E. R. (2002). How economics became a mathematical science. Durham: Duke University Press.
Yellen, J. L. (1984). Efficiency wage models of unemployment. The American Economic Review, 74(2), 200–205.
Yellen, J. (1995). Efficiency wage models of unemployment. In S. Estrin & A. Marin (Eds.), Essential readings in economics (pp. 280–289). London: Macmillan Education.
Acknowledgements
We appreciate helpful comments from Russell Lundholm (editor), an anonymous reviewer, Andrew Acito, Daniel Aobdia, Mary Barth, Scott Bronson, John Donovan, Josh Gunn, Chris Hogan, Patrick Hopkins, Andrew Imdieke, Harold Kazanabon, W. Robert Knechel, Bill Kinney, Mihir Mehta, Miguel Minutti-Meza, Jessie Watkins, and workshop participants at the University of Michigan, Idaho State University, the 2016 Indiana University Accounting Leading Scholars Symposium, the 2016 Illinois Audit Symposium, the 2017 International Symposium on Audit Research (Sydney), the 2017 Midwest Accounting Research Conference (UW-Madison), the 2018 AAA Audit Midyear Meeting (Portland), and the 2018 AAA FAR Midyear Meeting (Austin). We also express gratitude to the three anonymous Universities that provided us with undergraduate placement and salary data. Finally, we thank Kevin Hoopes for information regarding the H-1B visa data.
Author information
Authors and Affiliations
Corresponding author
Appendix
Appendix
Rights and permissions
About this article
Cite this article
Hoopes, J.L., Merkley, K.J., Pacelli, J. et al. Audit personnel salaries and audit quality. Rev Account Stud 23, 1096–1136 (2018). https://doi.org/10.1007/s11142-018-9458-y
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11142-018-9458-y