When Employees Go to Court: Employee Lawsuits and Talent Acquisition in Audit Offices

• Published date: 01 September 2024
• Author: JADE HUAYU CHEN
• Date: 01 September 2024
• DOI: http://doi.org/10.1111/1475-679X.12534

DOI: 10.1111/1475-679X.12534

Journal of Accounting Research

Vol. 62 No. 4 September 2024

Printed in U.S.A.

When Employees Go to Court:

Employee Lawsuits and Talent

Acquisition in Audit Off‌ices

JADE HUAYU CHEN ∗

Received 9 November 2021; accepted 9 February 2024

ABSTRACT

I examine whether employee-initiated lawsuits against an audit off‌ice

adversely affect its ability to attract high-quality talent and deliver quality au-

dits. I posit that employee lawsuits erode prospective employees’ perceptions

of an off‌ice, diminishing their willingness to join. Using a comprehensive data

set of individual auditor prof‌iles, I f‌ind a decline in the quality of newly hired

auditors following an employee lawsuit. Cross-sectionally, the adverse effectof

employee lawsuits on talent acquisition is more pronounced when an off‌ice

∗College of Business Administration, Loyola Marymount University

Accepted by Luzi Hail. This paper is based on my dissertation at the University of Arizona.

I thank my dissertation committee—Jayanthi Sunder (chair), Preeti Choudhary, Katharine

Drake, and Paul Michas—for their invaluable guidance and support. I also appreciate help-

ful comments from an anonymous associate editor, an anonymous reviewer, Pedro Gomez

(discussant), Timothy Haight, Aditi Khatri, Clive Lennox, Jacob Jaggi, James Pleˇ

cnik, Nuria

Seijas, Shoaib Shirazi, Joe Schroeder (discussant), Yini Wang, Mark Yan, WeiZhou, and work-

shop participants at the AAA/Deloitte Foundation/J. Michael Cook Doctoral Consortium, the

2022 Hawaii Accounting Research Conference, the 2022 AAA Auditing Midyear Conference,

University of Arizona, University of Manitoba, Central Michigan University, University of Col-

orado Denver,San Diego State University, University of Texas at Austin, California Polytechnic

State University-San Luis Obispo, Loyola Marymount University, and University of Texas at

Arlington. I am also grateful for funding provided by the GPSC Research and Project Grant

at the University of Arizona, the Dhaliwal-Reidy School of Accountancy at the University of

Arizona, and the College of Business Administration at Loyola Marymount University. An on-

line appendix to this paper can be downloaded at https://www.chicagobooth.edu/jar-online-

supplements

1265

© 2024 The Authors. Journal of Accounting Research published by Wiley Periodicals LLC on behalf of The

Chookaszian Accounting Research Center at the University of Chicago Booth School of Business.

This is an open access article under the terms of the Creative Commons

Attribution-NonCommercial-NoDerivs License, which permits use and distribution in any medium,

provided the original work is properly cited, the use is non-commercial and no modif‌ications or

adaptations are made.

1266 j. h. chen

is undergoing higher growth and when a case receives greater media atten-

tion. Conversely, this adverse effect is less pronounced when an audit off‌ice is

larger or offers more competitive wages within the local area. When an audit

off‌ice is unable to recruit high-quality talent, its audit quality is likely to suf-

fer. Consistent with this, I f‌ind a deterioration in audit quality provided by an

off‌ice following an employee lawsuit. Overall, this study underscores the im-

portance of human capital management and employer reputation for audit

off‌ices that operate in competitive labor markets.

JEL codes: J20, J24, J44, K31, M42

Keywords: employee lawsuits; human resources; individual auditors; audit

quality; restatements

1. Introduction

The audit industry is knowledge-intensive, with quality employees being a

key input into audit services (Aobdia, Srivastava, and Wang [2018], CAQ

[2018]). Recruiting and retaining quality employees is crucial to the per-

formance and success of public accounting f‌irms, especially given the sig-

nif‌icant talent shortages that characterize the audit labor market in recent

years (PCAOB [2015]).1Despite the importance of cultivating a skilled

workforce in the audit industry, we know very little about the factors in-

f‌luencing talent acquisition by audit f‌irms. In this study, I examine whether

employee lawsuits f‌iled against an audit off‌ice hinder an off‌ice’s ability to

recruit quality employees and provide quality audits.

Employee lawsuits are cases where employees sue their employers for vi-

olating employment and labor laws related to issues such as age, gender, or

race discrimination, harassment, benef‌its disputes, wage policy, and wrong-

ful termination. Investigating the labor market outcomes of employee law-

suits in the audit industry is relevant and important for multiple reasons.

First, employee lawsuits are prevalent in audit f‌irms. From 2005 to 2018,

25% of Big 4 audit off‌ices in the United States experienced such lawsuits.2

The associated costs, including legal fees, settlements, and reputation loss,

are often substantial (Unsal and Rayf‌ield [2019]).3Second, audit f‌irms

have faced a growing supply–demand gap of competent and qualif‌ied au-

ditors in recent years (AICPA [2019], Ellis [2022]), highlighting the need

for a deeper understanding of issues related to talent acquisition. Third,

audit professionals are sophisticated individuals who are likely to pay close

1A recent article in the Wall Street Journal highlights that high turnover in the audit indus-

try and the dwindling number of college graduates with accounting degrees contribute to a

deepening shortage of audit professionals, leading audit f‌irms to hire more temporary workers

(Ellis [2022]).

2I use the Audit Analytics Litigation Database to identify employee lawsuits citing U.S. Big

4 audit f‌irms as defendants.

3Among cases with available outcome information in my sample, the largest legal settle-

ment is $11.6 million.

employee lawsuits and talent acquisitionin audit offices 1267

attention to issues of workplace equity and employee treatment when eval-

uating potential employers (Glaeser and Saks [2006]). Therefore, they are

likely to react and respond to employee lawsuits. The audit industry also

has unique features that facilitate an examination of employee lawsuits

and their economic consequences. Specif‌ically, large audit f‌irms operate

in similar organizational structures, which allows me to compare lawsuit ef-

fects across different audit off‌ices or position ranks. Furthermore, the audit

setting provides observable audit performance indicators, such as restate-

ments and discretionary accruals, which offers an avenue for evaluating the

implications of employee lawsuits for audit quality.

An off‌ice’s involvement in employee lawsuits provides a salient signal of

its working conditions and corporate culture, casting it in a bad light in

the labor market (Turban and Greening [1997], Benson, Sojourner, and

Umyarov [2020]). For example, cases related to wage disputes and wrong-

ful termination convey unfavorable information about the extent to which

an off‌ice supports and cares about the well-being of its employees (Lind

et al. [2000]). Similarly, cases of gender bias or race discrimination convey

adverse information about an off‌ice’s practices in managing diversity and

equity (e.g., Williams and Bauer [1994], Van Knippenberg, Homan, and

Van Ginkel [2013], Dalton et al. [2014]). These lawsuits often attract sig-

nif‌icant media attention, amplifying the detrimental impact on an off‌ice’s

reputation (Grinblatt and Keloharju [2001], Giannetti and Wang [2016],

Carnes, Christensen, and Madsen [2023]).

Moreover,as litigation could result in substantial payouts in legal fees and

settlements (Unsal and Rayf‌ield [2019], Lennox and Li [2020]), prospec-

tive employees may have concerns about an off‌ice’s ability to uphold its

commitments to its employees and even its long-term viability following an

employee lawsuit. The potential litigation liability associated with lawsuits

may also raise concerns among prospective employees about an off‌ice’s fu-

ture client attraction and retention, which could compress future compen-

sation levels and exacerbate future work pressures. Thus, to the extent that

competent job applicants value an audit off‌ice’s work culture and treatment

of its employees and can differentiate themselves in the labor market, they

may be less inclined to join an audit off‌ice after an employee lawsuit.

One major empirical challenge in investigating the labor market out-

comes of employee lawsuits is that employment data for individual auditors

are not widely available. I overcome this challenge by collecting publicly

available professional prof‌iles of all individuals who report any instance of

working in an audit position at a U.S. Big 4 accounting f‌irm.4I then extract

all available information from these prof‌iles and construct measures of in-

dividual auditor quality based on an individual’s educational background,

4Individual prof‌iles are available on professional networking and recruiting Web sites, with

over 775 million prof‌iles available as of 2021. The breadth and granularity of this data allow

me to evaluate the composition of the workforce across audit off‌ices. I evaluate the represen-

tativeness and precision of this data in subsection 3.2.