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

investigate whether a loss of labor market reputation adversely affects audit offices’ ability to attract high-quality auditors, which, in turn, could impede their ability to provide high-quality audits. Labor market reputation captures prospective employees’ perceptions of a firm and its desirability as an employer. Using employment-related lawsuits that plausibly erode an audit office’s labor market reputation, and a novel dataset of individual auditor resumes, I find that employee lawsuits harm the sued audit office’s ability to attract talent. Specifically, I find that employee lawsuits lead to a decrease in the likelihood of an audit office attracting auditors who graduated from top-ranked universities or accounting programs, or those with more work experience. The adverse effect of employee lawsuits is more salient when hiring auditors at senior positions and is mitigated when an audit office is larger or pays higher wages in the local area. Further, following the lawsuits, I find a deterioration in audit quality, as measured by financial restatement propensity. Finally, I use mediation analysis to show that an office’s inability to attract quality applicants is one channel through which reputation affects audit quality. Overall, my study highlights the importance of human capital management and reputation building in enhancing audit offices’ position in a competitive labor market