Do Audit Personnel Salaries Impact Audit Quality? Jeffrey L. Hoopes Kenneth J. Merkley Joseph Pacelli Joseph H. Schroeder Illinois 22 nd Symposium on Audit Research October 14, 2016
Team HMPS Jeff Hoopes Joseph Pacelli Ken Merkley University of NC Cornell University Indiana University 11/15/2016
Motivation: Increasing Expectations PCAOB focused on high quality audits Audit quality is a function of process and people Since 2004 Amount of work has increased significantly - Personnel tasked with increasing responsibilities - Increased time pressure to complete audits - Increased pressure to perform high quality audits - Financial Accounting and Disclosure is becoming more complex
Motivation: What Audit Firms Need Big 4 recruiters want students that have the following skills: Critical thinking ability - Professional skepticism - Soft skills - Data analytic skills - PwC white paper on accounting curriculum Advanced statistics - Econometrics - Programming ability - Audit firms aim to attract the best and the brightest professionals
Motivation: What Audit Firms Need “Our reputation depends on hiring the most talented professionals available and, in turn, our reputation for quality enables us to attract the best candidates” (PwC 2015) “Retention is critical to achieving sustained audit quality. Our strategies for hiring and developing the best and the brightest in the profession become irrelevant if our professionals choose to leave the firm” (PwC 2014)
Motivation: Current Hiring Environment Auditors’ real salaries have remained flat the past decade Emergence of high growth consulting practices Students shifting from audit to consulting Students shifting from Big 4 to alternative career paths Audit fee growth has been slow or flat
Research Questions How does audit personnel salaries relate to audit quality? Are audit firms able to pass on differences in audit personnel salaries to their clients via audit fees? Audit Office Quality +/- Audit Personnel (Average audit office client Quality/Motivation portfolio misstatement rate) (Salary as obtained from Audit Office Pricing +/- H1-B visas) (Average audit fees for office)
Prior Research Audit Partner Compensation studies Sweden partner compensation ~ Knechel et al. 2013 - U.S. partner compensation plans ~ Carcello et al. 2000 - Human Capital Studies Audit quality higher in cities with better human capital (i.e. education) ~ - Beck et al. 2016 Audit Office Size - Larger offices provide higher quality audits ~ Francis and Yu 2009 Foreign Labor - Does not impact overall office salaries or fees ~ Aobdia et al. 2016
Prior Research PwC (2015) Report 1 hour of partner time = 20.2 associate hours - 1 hour of partner time = 3.9 manager hours - Limited research on rank-in-file personnel Partners overestimate lower level personnel ability ~ Messier et al. - 2008 Audit Personnel Compensation is a “Black Box” with limited data availability
The job decision: Almer, Higgs and Hooks 2005 BRIA Salary
H1: Audit Salary and Audit Quality Higher wages: Attract more skilled and capable workers 1. Motivate existing personnel to perform better 2. Higher Better and more Higher office Salaries motivated level audit employees quality
The job decision: Almer, Higgs and Hooks 2005 BRIA Salary Deferred Value to Society Compensation & Profession Work Life Professional Balance Development
H1: Audit Salary and Audit Quality Trade-off salary for future opportunities and professional training/development Audit process is quite standardized, thus rank-in-file employees might not matter There may be no effect or even a negative effect
H2: Audit Salary and Audit Fees Profit maximizing firm should increase audit fees (i.e. revenues) if salaries (i.e. costs) are increasing Higher Audit Fees Clients demand for higher audit quality ~ Francis et al. 2005; Allee and - Yohn 2009; Minnis 2011 No Effect on Audit Fees Audit industry is competitive and commoditized ~ IFIAR 2014 - Clients do not have the ability to pay higher audit fees -
Hypotheses H1: Audit personnel salaries are not associated with audit quality H2: Audit personnel salaries are not associated with audit fees
Data and Sample H1-B Visas required for all foreign employees Obtained via FOIA Application provides the following: - Audit firm - Office location - Job title (i.e. audit, tax, consulting) - Rank - Date of application/hire 11/15/2016
Data and Sample 11,536 H1-B Visas (2004 to 2013) Audit personnel salaries = Avg. of H1-B Visas by audit-office- year Compute measures by rank - Associate/Staff - Senior - Manager Restrict to Big 4 Audit Firms 11/15/2016
Data and Sample Validate data by: 1) Comparing staff/associate salaries to University Hiring Data 2) Salary guides 11/15/2016
Data Sources and Dependent Variable Data Sources Compustat - Audit Analytics - FBI, Zillow, Bureau of Labor Statistics - Office Audit Quality Measure Percent of clients within the office that experience a misstatement, - restated in future periods Sample period 2004 to 2013
Multivariate Models Analysis 1: Determinants Model β 0 + β 1 RANK + β 2 JOBCOMPLX + β 3 AUDMKTSHR + = LNSALARY β 4 OFFICE_AQ + β 5 LNHOMEP + β 6 LNPOP + β 7 VCRIME + β 8 EDUCATION + year indicators + ε Analysis 2: Quality Model (Test of H1) β 0 + β 1 LNSALARY + β ’s(Controls for client characteristics that = RESTATE% determine misstatements) + β ’s(Controls for MSA characteristics) + Rank FE + Year FE + MSA FE + ε Analysis 3: Fee Model (Test of H2) β 0 + β 1 LNSALARY + β ’s(Controls for client characteristics that LNFEES = determine fees) + β ’s(Controls for MSA characteristics) + Rank FE + Year FE + ε
Multivariate Models Aggregation at the H1-B visa application level Allows us to examine ranks pooled together - Allows us to better examine economic factors associated with salary - Standard errors clustered by audit-office and year - Further aggregation for audit quality analysis MSA level - Client level -
Observations by year Year # of Observations % of Sample 2004 806 7.0% 2005 900 7.8% 2006 1,105 9.6% 2007 1,560 13.5% 2008 1,340 11.6% 2009 1,175 10.2% 2010 1,009 8.7% 2011 1,344 11.7% 2012 1,416 12.3% 2013 881 7.6% TOTAL 11,536 100%
Observations by Audit Firm Year # of Observations % of Sample PwC 1,046 9.1% Ernst & Young 4,752 41.2% Deloitte 2,761 23.9% KPMG 2,977 25.8% TOTAL 11,536 100%
Observations by MSA Year # of Observations % of Sample New York-Newark-Edison, NY-NJ-PA 3,468 30.1% San Jose-Sunnyvale-Santa Clara, CA 823 7.1% Los Angeles-Long Beach-Santa Anna, CA 810 7.0% Boston-Cambridge-Quincy, MA-NH 660 5.7% San Francisco-Oakland-Freemont, CA 595 5.2% Washington-Arlington-Alexandria, VA-MD 584 5.1% Houston-Baytown-Sugar Land, TX 524 4.5% Dallas-Fort Worth-Arlington, TX 445 3.9% Philadelphia-Camden-Wilmington, PA-NJ-DE 417 3.6% Atlanta-Sandy Springs-Marietta, GA 415 3.6% Other MSA 2,795 24.2% TOTAL 11,536 100%
Auditor Pay Across Time
Auditor Pay Across Time Pooled PwC EY Deloitte KPMG Associate $ $54,919 $60,034 $55,465 $51,604 $54,440 Associate N 5,547 505 2,702 1,036 1,304 Senior $ $72,193 $72,410 $75,387 $65,939 $73,349 Senior N 4,267 369 1,571 1,051 1,276 Manager $ $87,082 $90,355 $94,308 $74,771 $97,845 Manager N 1,722 172 479 674 397
Analysis 1: Determinants of Auditor Pay
Analysis 1: Determinants of Auditor Pay
Analysis 2: Auditor Salary and Audit Quality Full Sample Associates Seniors Managers Pred. Coef. Coef. Coef. Coef. Sign (t-stat) (t-stat) (t-stat) (t-stat) LNSALARY +/- -0.0254*** -0.0298*** -0.0200*** -0.0369*** (-3.77) (-3.16) (-2.90) (-3.09) Controls Yes Yes Yes Yes Rank FE Yes Yes Yes Yes Year FE Yes Yes Yes Yes Observations 11,536 5,547 4,267 1,722 R 2 0.182 0.186 0.196 0.204
Analysis 2: Auditor Salary and Audit Quality with MSA fixed effects Full Sample Associates Seniors Managers Pred. Coef. Coef. Coef. Coef. Sign (t-stat) (t-stat) (t-stat) (t-stat) LNSALARY +/- -0.0202*** -0.0268*** -0.0172*** -0.0280*** (-3.16) (-3.03) (-2.59) (-2.58) Controls Yes Yes Yes Yes MSA FE Yes Yes Yes Yes Rank FE Yes Yes Yes Yes Year FE Yes Yes Yes Yes Observations 11,536 5,547 4,267 1,722 R 2 0.182 0.186 0.196 0.204
Analysis 2: Auditor Salary and Audit Quality Aggregation at MSA Audit Office Level (OLS) Associates Seniors Managers Pred. Coef. Coef. Coef. Sign (t-stat) (t-stat) (t-stat) LNSALARY +/- -0.0811** -0.0276 -0.0619*** (-2.52) (-1.34) (-3.04) Controls Yes Yes Yes MSA FE Yes Yes Yes Rank FE Yes Yes Yes Year FE Yes Yes Yes Observations 1,009 805 525 R 2 0.260 0.248 0.466
Analysis 2: Auditor Salary and Audit Quality Aggregation at client level (logistic regression) Associates Seniors Managers Pred. Coef. Coef. Coef. Sign (t-stat) (t-stat) (t-stat) LNSALARY +/- -0.5988** -0.4037* -0.6362*** (-1.85) (-1.79) (-2.62) Controls Yes Yes Yes MSA FE Yes Yes Yes Rank FE Yes Yes Yes Year FE Yes Yes Yes Observations 16,410 14,465 10,413 Pseudo R 2 0.087 0.089 0.094
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