2.02: Audit Firm Strategy and Personnel Dynamics

Motivated by the waves of mergers and acquisitions (M&As) among accounting firms and the growing talent crisis in the audit industry, we investigate how M&As affect employee turnover and client relationships. We hypothesize that M&As act as employment relationship shocks that increase audit employee turnover and that such post-merger integration frictions hinder performance of the merged firm. Using employee-level data, we find that employee turnover rises sharply following M&As for both target and acquiring firms, with a substantially larger effect for target firms. High-quality employees are more likely to leave target firms but more likely to stay in acquiring firms, suggesting that target firm employees face greater job disruption, while acquiring firm employees may see new career opportunities. We observe no difference in turnover rates for female or minority employees, suggesting that post-M&A structural changes do not disproportionately affect these groups. Finally, we document that higher turnover at both target and acquiring firms is associated with lower client retention, suggesting that talent loss undermines client relationships. Our study contributes to the literature on human capital by highlighting the labor frictions associated with accounting firm structural changes and the downstream effects on client relationships. 

We examine how PCAOB enforcement actions against individual auditors
influence the audit quality of non-sanctioned auditors within the same office, conditional on
whether sanctioned auditors depart or remain with their firm. Using a difference-in-differences
(DID) design, we find that audit quality improves when sanctioned auditors depart but deteriorates
when they remain. To address concerns about endogeneity and biases in staggered DID designs,
we conduct several robustness tests that confirm our main findings. Additional analyses reveal that
audit quality improvements (deteriorations) are mainly driven by large (small) audit firms and are
more pronounced when the sanctioned auditor faces a longer suspension, is more senior, or is
sanctioned for audit quality (non-audit quality) issues. Our findings provide novel evidence that
the labor market consequences of sanctioned auditors result in differential spillover effects on their
colleagues' audit quality. These results offer timely insights amid the PCAOB's increasing
emphasis on individual accountability. 

I examine the audit consequences associated with financial misconduct by a firm within a strategic alliance. Core earnings restatements, which involve corrections to a firm's primary operational activities, such as revenues, cost of goods sold, and selling, general, and administrative expenses, are particularly relevant to its alliance partners. I find evidence that audit fees increase for allied partners following a core earnings restatement. This increase does not appear to be driven by more audit effort but from an increased risk premium, to compensate for the higher perceived audit risk, and is concentrated on contractual alliances rather than joint ventures. Additional analyses indicate that this effect is not limited to core earnings restatements but extends to fraudulent restatements. Cross-sectional tests reveal that the spillover effect deriving from core earnings restatements is concentrated among firms with lower accruals quality, while the spillover effect deriving from fraudulent restatements is concentrated among firms with better accruals quality. Overall, this study indicates that financial misconduct in one firm has detrimental consequences to allied partners' perceived audit risk, which translates into higher audit fees.