Non-audit services are a key component of an auditor’s offerings to their clients. With them, auditors can market their unique expertise and provide services far surpassing the necessities of an audit. In this paper, I study the effect of local competition on auditors’ use of non-audit services. My findings show that auditors respond to intensifying competition by increasing their emphasis on selling non-audit services. This response is especially strong when there exists a wide range in the audit qualities being offered by competing firms or when audit fees are depressed, suggesting that non-audit services function as both a differentiation tool for higher quality firms as well as a supplementary revenue stream when audit fees are reduced. I also find that the use of non-audit services reduces audit quality, especially in highly competitive environments, indicating that the types of non-audit services sold in competitive markets are more detrimental to audit quality than those sold elsewhere.

Trade-Offs in the Relationship Between Competition and Audit Quality

Following the mergers of the late 20th century and the fall of Arthur Andersen in 2002, fears over public accounting becoming increasingly concentrated have led to many attempts to study the relationship between competition and audit quality. These studies have yielded conflicting results without a clear reason as to why. In this paper, I propose and empirically demonstrate a non-monotonic association between competition and audit quality. Using MSA level data from the United States over the period of 2000-2014, I show that the effect changes in competition will have on audit quality will depend upon the current competitive state of the market and that audit quality is maximized when competition is neither too high or too low. In addition, I find that the point of inflection at which competition turns from being helpful to harmful is influenced by the saturation of the Big 4 auditors in the market. These findings can help explain the mixed results of the literature as well as provide insight to the role that regulators can play in modulating competition.

Labor Flow and the Hiring of Aspiring Public Accountants

Public accounting firms continuously train and hire new talent, with the goals of attracting high quality workers and retaining them long-term. However, firms are forced not only to compete with other firms for untrained workers but also face the threat of losing their employees to other firms or the non-public accounting sector after training is complete. In this paper, I model the two stages of staffing that public accounting firms face in a two period matching model. In the first stage, firms compete for the opportunity to hire and train workers, and in the second stage workers are given the opportunity to rematch once training is complete and their productivity is revealed. I find that, given that larger firms produce more efficiently than smaller firms, the first period equilibrium is determined by the distinguishability among worker types. I also find that larger firms retain a higher percentage of trainees and grow faster in expectation. Additionally if worker types are not sufficiently distinguishable, overall industry output quality will decrease.

Using job history data on accounting employees working at S&P 1500 firms, we study whether firms display a preference for auditors from whom they have more alumni, as well as if employee hiring patterns are driven by a firm’s choice of auditor. We find that a one standard deviation increase in an auditor’s alumni rate within a firm increases the likelihood of that auditor being chosen by 5.1 percentage points. This is economically significant given that no single Big 4 firm accounts for more than 31.6% or less than 20.9% of the audits within our sample. Our switch analyses are consistent with these results, suggesting that firms favor auditors from whom they have more alumni when selecting a new external auditor. We also find that firms alter their hiring agenda in favor of the incoming auditor after a switch and that the changes to hiring preferences persist as auditor tenure grows. Robustness tests indicate that these findings are not a result of reverse causality.

Non-executive accounting employees are “affiliated”, or alumni, if they previously worked for their companies’ audit firms. Using a unique data set consisting of job histories of accounting employees working at S&P 1500 companies who were previously employed at public accounting firms, we study the effect of alumni affiliations on audit quality. We find that companies with a larger proportion of alumni among their accounting employees are significantly less likely to issue financial misstatements, and have lower absolute abnormal accruals. Our results shed light on the way non-executive accounting employees affect audit quality, and are of practical importance to the hiring of accounting employees by industry companies.