Two Essays on Audit Partner Human Capital
This dissertation comprises two essays that explore the practice of audit partner human capital management in audit firms. A partner's human capital includes the partner's ability and competencies that allow her to fulfill assigned tasks. Prior literature provides little evidence on how audit firms makes audit partner assignment (to engagements) decision based on audit partner ability. This study aims to provides initial evidence of such process. In the first essay titled "A New Measure of Audit Partner Ability", I propose new measures of audit partner ability. The limited data on audit partners in the U.S. pose challenges in capturing audit partner ability. By employing the two-stage procedure of Data Envelopment Analysis (DEA) and OLS regression (Liu, Ondrich, and Ruggiero 2012; Demerjian, Lev, and McVay 2012), I develop the alternative measures that are more feasible to construct using the limited audit partner data in the U.S. The measures are based on an audit partner's efficiency, compared to her peers, in controlling client opportunistic financial reporting behaviors. I find that my measures are positively associated with the coefficients of the individual partner fixed effects in the audit quality model. Further, I find that my measures of partner ability are mainly explained by individual partner fixed effects as opposed to client fixed effects. These findings suggest that my measures capture individual audit partners' abilities in providing high audit quality. In the final test, I find that partners with higher abilities are faster in discovering accounting misstatements. Overall, the results of these tests support the construct validity of my measure of audit partner ability and point to the possibility of employing this measure in future research. In the second essay titled "Audit Partner Assignments: Evidence from the matching of Audit Partners Ability and Client Engagement Risk", I examine how audit firms match audit partner ability with client engagement risk. The PCAOB's Quality Control Standard QC 40 requires that audit firms need to have a personnel management strategy that assures audit partners possess appropriate competencies to lead engagements. Applying the partner ability measure developed in the first essay, I show that audit partner assignment decisions are driven by the risk of the audit engagement. Specifically, I find that audit firms assign audit partners with higher abilities to the engagements of more important clients and first-time clients. Further, I find that in a partner rotation event an audit firm would assign a rotate-in partner with higher ability than the rotate-out partner if the audit quality of the rotate-out partner is low. Finally, I find some evidence that Big 4 firms, bigger audit offices and more complex operation are more likely to use engagement risk as a driver for audit partner assignment decision, which is consistent with the PCAOB's proposal to make the quality control standard scalable in the future. Overall, these findings should assist the PCAOB in evaluating the current quality control standards and making necessary changes in the forthcoming revisions.