Corporate Employment, Red Flags, and Audit Effort

Posted: 11 Jan 2018 Last revised: 7 Dec 2019

See all articles by Jian Cao

Jian Cao

Florida Atlantic University

Xin Luo

Marquette University

Wenjun Zhang

Dalhousie University

Date Written: November 30, 2019

Abstract

U.S. regulatory agencies and congressional oversight committees have expressed concerns that auditors often neglect red flags embedded in the operating characteristics of firms that misstate their financial reports. This study examines whether labor employment decisions, a major part of a firm’s operations, help predict accounting improprieties and consequently play a role in audit planning and pricing. We find that negative abnormal employment changes are associated with a higher likelihood of subsequent financial restatements, accounting irregularities, and lawsuits related to accounting fraud, and generally require greater effort from auditors as manifested by higher audit fees and longer audit report lags. Positive abnormal employment changes are associated with subsequent restatements and longer audit report lags, but not associated with fraud or audit fees. Taken together, the results are consistent with auditors recognizing the individual misstatement risks pertaining to companies’ employment decisions. These results suggest that standard setters, regulators, and practitioners should devote more attention to operational statistics to identify potential red flags.

Keywords: audit fee, audit delay, audit risk, restatement, fraud, labor input and employment

JEL Classification: M42, M41, J20, D21

Suggested Citation

Cao, Jian and Luo, Xin and Zhang, Wenjun, Corporate Employment, Red Flags, and Audit Effort (November 30, 2019). Journal of Accounting and Public Policy, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3099668 or http://dx.doi.org/10.2139/ssrn.3099668

Jian Cao

Florida Atlantic University ( email )

777 Glades Rd.
Boca Raton, FL 33431
United States
561-297-3727 (Phone)

Xin Luo

Marquette University ( email )

David A. Straz, Jr. Hall
Milwaukee, WI 53233
United States

Wenjun Zhang (Contact Author)

Dalhousie University ( email )

Halifax
Canada

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