The offices of Big Four accounting firms that pay lower salaries for audit help have a higher portion of clients that experience restatements, according to a new study posted Tuesday.
“We obtain a sample of data on how much Big Four accounting firms are paying their auditors, and find that, controlling for the type of office, city, and a whole host of other factors, the more you pay your auditors, the fewer restatements you get in an office,” Jeffrey L. Hoopes, an assistant professor of accounting at the University of North Carolina and a co-author of the study, writes in an email to CFO.
“In other words, you get what you pay for. While this result may seem intuitive, it has not been documented in large samples previously,” Hoopes contends. “It seems a truism, but it’s surprising to me that it hasn’t trickled down and resulted in firms paying more” for audit help, he said later, noting that firms are paying more for consulting, tax, and information systems work.
The takeaway for CFOs? “If you want a good audit, make sure your auditors are well paid,” Hoopes says.
Finance chiefs might also want to be aware of another finding reported in the unpublished research paper: Their companies may be paying for some of the costs of their auditors’ cheapest labor. On average, “audit firms appear to be able to pass some costs of their marginal labor onto their clients,” the authors write. “We find that this relationship is most pronounced among associates and is less pronounced for the senior and manager ranks.”
Basing their study on a sample of about 13,000 salaried Big Four employees during the period from 2004 to 2013, the researchers found that the average associate earns $54,356 per year, while seniors and managers earn substantially higher average salaries of $71,663 and $86,730, respectively. “While salaries have risen from 2004 to 2013, we find that inflation-adjusted salaries have remained stagnant, and in some cases, have actually declined,” they write.
Across the audit firms in the sample, KPMG seems to have paid the highest average salary ($67,618 per year), while Deloitte paid the lowest ($62,467). KPMG appears to have paid the highest salary ($97,538) for audit managers.
Hoopes noted that some observers might argue that staff auditors don’t sign up at a Big Four firm for the money. Rather, they sign on for the experience, hoping to apply that experience at a different job later. The data dug up by the researchers suggests, however, “that paying a little more may indeed attract higher quality folks that do a better job auditing,” he wrote in his email.
Noting that the idea of paying entry-level audit help more attractive salaries may be a “heresy” to some audit partners, Hoopes recalled a conversation he had with a partner at a Big Four firm in Detroit at the height of that city’s economic woes. The partner told the professor how hard it was to attract quality candidates to Detroit.
“I asked why they didn’t just pay more. Different recruiting strategies on college campuses, etc., might be helpful, but, all else equal, just paying more might bring those folks back to Detroit,” Hoopes wrote.
“The partner stared at me as if I had spoken some great heresy, then had some excuse for not paying more,” he added
Salaries and Audit Quality
The study examines the relationship between audit personnel salaries and office-level audit quality. It gauges audit personnel salaries at the associate, senior, and manager ranks for Big Four audit offices using data obtained from the U.S. Department of Labor.
“We find that offices that pay lower salaries have a higher percentage of clients that experience restatements. In related analysis, we also find lower levels of audit quality when audit employees are paid less relative to other lines of service in accounting firms (tax, consulting, etc.),” Hoopes wrote in the email.
While understanding the relationship between pay and performance “is important to the audit profession, prior research has not examined the implications of audit personnel salary for audit quality because auditor salary information is not readily available,” the authors contend in the paper.
The researchers write that they overcame that data limitation by using about 13,000 publicly available worker visa applications provided by the U.S. Department of Labor, as a proxy for the salaries offered to audit personnel across 185 local U.S. offices of Big Four audit firms.
The visa applications provided researchers with the application year, audit firm identity, office location, service line, rank, and salary. Although visa applications are issued to non-U.S. citizens, the authors write that it’s important to note that the visa program bars audit firms from offering salaries that are less than the wage offered to domestic college graduates.
“Consequently, the salary data used from these visa applications provide a reasonable proxy for the prevailing wage offered to all entering personnel for each audit firm office,” the researchers write. “We also restrict our analysis to Big Four firms as they consistently employee foreign labor across all audit offices, thus allowing us to construct salary measures necessary for our analysis.”
Besides Hoopes, the other co-authors of the research paper are Kenneth J. Merkley, Cornell University, and Joseph Pacelli and Joseph H. Schroeder, both of Indiana University.