Auditor Labor Market Mobility Constraints and Audit Outcomes: Evidence from Enforceability of Non-Compete Covenants

Description

The audit industry is characterized by both high human-capital-intensity and high labor mobility. Audit firms have commonly used non-compete covenants (NCCs), i.e., employment contract provisions that prohibit departing employees from joining or forming a competing firm. In fact, the usage of NCC in audit firms is a particularly relevant issue nowadays given the COVID-19.  A recent article in the Thomson Reuters Westlaw Today entitled "Employees Laid Off As A Result Of COVID-19 Ask Courts To Find Their Non-Compete Agreements Unenforceable" directly reports an exemplary case.  Kyle Blessinger, a certified public accountant, filed a lawsuit on June 18, 2020, against his former employer Wipfli, LLP, a large audit firm. He is seeking a declaratory judgment that the non-competition and non-solicitation covenants he signed are invalid and unenforceable under Montana law and public policy.NCCs have been widely used in the United States, especially among skilled and highly-paid workers. However, the enforceability of NCCs is governed by state laws and thus may vary across states and over time. For instance, while California virtually bans the enforcement of NCCs, Florida allows NCCs to be easily and broadly enforced. Extant research examining the effects of NCCs mainly focuses on the CEO labor market, although other labor markets, such as financial advisor, mutual fund manager, physician, and technician labor markets have been investigated also.However, research on the impacts of NCCs is still lacking in the accounting literature. The review article by Lennox and Wu (2018) explicitly suggests that a study on the question “What are the effects of non-compete clauses?” could be a fruitful avenue of research. To fill the gap and answer the call from Lennox and Wu (2018), this proposal examines whether and how auditor labor market mobility constraints imposed by NCCs affect a range of issues pertinent in the audit industry: i.e., the audit client poaching, audit market structure, audit quality, and audit pricing. Specifically, our research adopts a generalized difference-in-differences approach by exploiting the staggered state-level exogenous changes in NCCs enforceability from 2000 to 2020, recently collated by Ewens and Marx (2018).This project could enrich the archival audit research on how supply-side factors determine the audit quality (DeFond and Zhang, 2014). Furthermore, this project adds to the growing literature on the effects of NCCs. Finally, the results can provide novel insights into the costs and benefits of NCCs, and valuable guidance to audit practitioners in the U.S. and Hong Kong.