Unfair Labor Practice Charges and Audit Fees. Bill Francis Rensselaer Polytechnic Institute Lally School of Management

Unfair Labor Practice Charges and Audit Fees Bill Francis Rensselaer Polytechnic Institute Lally School of Management francb@rpi.edu Iftekhar Hasan Fordham University and Bank of Finland ihasan@fordham.edu Qiang Wu Rensselaer Polytechnic Institute Lally School of Management wuq2@rpi.edu Ibrahim Siraj Long Island University-Post ibrahim.siraj@liu.edu 1

Unfair Labor Practice Charges and Audit Fees Abstract We examine how auditors respond to the accusation of unfair labor practices against their client firms. The National Labor Relations Act 1935 made it illegal for the employers to violate the employee rights of unionization. Violation of this rights could be result in unfair labor practice charges with the assistance of the National Labor Relation Board. We find that auditors charge significantly higher audit fees in the periods of post-filing of unfair labor practice allegations against the client firms than in the periods of pre-filing. The two types of unfair labor practices that receive the most negative reaction from the auditors are discriminating against employees because of their involvement in unionized activities, and the refusal to bargain with good faith with union representatives. 2

Unfair Labor Practice Charges and Audit Fees 1. Introduction Prior literature provides evidence suggesting that labor unions play in important role in making of major corporate decisions. 1 Unions also influence practices of corporate disclosure (e.g., Mora and Sabater, 2008; Leung et al, 2012, Bova, 2013). Having such far reaching effects of unions in different areas of corporate policies, literature is still scarce in showing how disputes between the unions and the employers could affect corporate outcomes, especially the eventual reassessment of risk from the perspective of outsiders. We address this issue by investigating how auditor respond to the firms that are officially in dispute with labor unions. Unions have strong collective bargaining power and can pose credible threats of strikes or closing down of firms to come to a favorable agreement with the employers (Hirsch, 1991; 1998). Such collective pressure of unions could significantly increase the litigation risk and make reputational damage of a firm. Thus auditors, to avoid their own litigation risk and reputational damage, are likely to put greater effort in assessing financial report of firms that experience conflicts with unions. Also as unions encourage practices of fair corporate disclosure, their weak and neglected presence inside the firms might make the auditors more concerned about earnings report. Because of these negative outcomes associated with disputes between unions and firms, we posit that auditors would charge higher audit fees for the firms at the post-accusation period of unfair labor practices with unions than pre-accusation periods. Our empirical evidence supports this prediction. 1 For example, labor unions could affect corporate investment and financing decisions (e.g., Klasa et al., 2009; Chen et al., 2011), compensation of executives (Gomes and Tzioumis, 2006), corporate governance (Agrawal, 2008; Prevost et al., 2012), and tax aggressiveness (Chyz et al., 2013). 3

In this paper, we focus on violations of employee rights of conducting unionized or group activities to identify unfair labor practices of a firm. The rights of unionization was first enacted by the National Labor Relation Act (henceforth, NLRA) 1935. Employers or unions can file unfair labor practice charges against a firm if the employers violate the employee rights of unionization. The National Labor Relation Board (henceforth, NLRB) is the responsible organization to initiate and supervise the investigation and legal proceeding of such allegations against the firms. In most of the cases, unfair labor practices charges end up with employers compliance with the decision of board, or court, or withdrawal with adjustments. We find that, compared to the audit fees at the periods of pre-filing of unfair labor practices charges, the audits fees are significantly higher in the periods of post-filing of charges. A charge can be filed by an individual employee or by labor union. We focused on the charges filed by union. There are five types of unfair labor practices that NLRA made illegal to commit. 2 We further posit that auditors respond should vary across the types of charges filed. For example, one type of unfair labor practice is employers interference in employees involvement in group or unionized activities. This type of practice usually takes place in the early stage of disputes with union or when the hostile environment between management and union is not much alarming. But other types of practices, such as discriminating employees because of their involvement in union could turn out to be a serious source of resentment and threat from union. Also employers refusal to bargain with good faith with union representative can indicate a conflict at a mature stage. Therefore we further predict that accusations of discrimination and refusal to bargain would receive the most negative response from the auditors. We find that auditors charge significantly 2 Appendix A provides description of each type of unfair labor practice. 4

higher audit fees when employers commit unfair labor practices of discrimination or refusal to bargain. Our results are robust to the approach of difference-in-differences approach. Our results should provide multiple contributions in the literature related to labor union, and audit fees. First, even though there is a large body of literature that examines how labor union affects different areas of corporate decisions, we are one of the first to show how conflicts between labor unions and the employers would affect risk assessment and effort of auditors. Second, prior empirical evidence suggests that labor unions encourage adoption of accounting conservatism as financial reporting practices (Leung et al., 2009; Farber et al., 2010), whereas accounting conservatism is associated with reduction of audit fees (Lee et al., 2015), we argue that weak voice of union inside the firms, resonated by the presence of dispute between union and employers, should provide less incentives for the managers to employ conservative reporting practices. Our finding of positive association between unfair labor practices and audit fees might imply that auditors, besides readjusting the client firms business risk and litigation risk upward, put greater effort in assessing the earnings reports. Third, prior literature argues that unions have collective bargaining power that could pose credible threats to the future of operation of the firms (Hirsch, 1991, 2008), which could further increase the litigation risk and the risk of loss of reputation of the client firms. Such concern should also increase the litigation risk and the likelihood of reputational damage of auditors. Our results support this notion that auditors being concerned of their litigation and potential damage in reputation would charge higher fees to the firms involved in serious disputes with unions. The rest of the paper is organized as follows. We discuss on relation literature and build our hypothesis in section 2. We discuss on data and methodology in section 3. The results from empirical analysis is discussed in section 4. Section 5 concludes the paper. 5

2. Literature Review and Hypothesis Development 2.1. Labor unions and corporate disclosure practices Labor unions likely have interests in firms that could differ with what interests that managers and shareholders might hold. Similar to shareholders as residual claimants, managers might have a substantial portion of compensation package linked with residual claims. Thereby both managers and shareholders could have limited downside risk, whereas their claims on firm value are increasing with cash flow volatility. On the other hand, employees as well as labor unions might have interests in firms that imitate the interests of bondholders (Faleye et al., 2006). Similar to risky debts, contracts of employees contain fixed claims on the firm value. Thus employees with claims like bondholders, whereas claims of bondholders are decreasing with the risk in cash flow (Merton, 1974), would be more risk averse than managers and shareholders. Corporate disclosure practices play an important role in empowering the employees dealing with the risks associated with employment. Prior literature in labor economics argues that employees experience a substantial amount of losses when they lose their jobs, which includes different types of hardships such as sharp drop in consumption expenses (Gruber, 1997), struggles in finding an expected job (Farber, 2005; Gibbons and Katz, 1991). Employees largely depend on earnings report in figuring out their unemployment risk. As employers have to pay a considerable compensating wage differentials to compensate for risks associated with unemployment (Topel, 1984; Hamermesh and Wolfe, 1990), they often tend to manage market perception of unemployment risk by producing biased financial reports. For example, firms can manage earnings upward that make the employees stable in the adjustment of unemployment risk. Brown et al. (1995) provide empirical evidence suggesting that firms, in order to make a favorable agreement with employees, often commit to 6

accounting practices that increase long run income. Other empirical work finds out that keeping up with implicit claims associated with an employment contract motivates the managers to bypass negative earnings surprises (Matsumoto, 2002; Cheng and Warfield, 2005), manage balance sheet (Zechman, 2010). Issues with dealing with labor unions could make the managerial incentives of earnings management more intense and complicated. Unionized employees, while negotiating with employers, have greater bargaining power than their nonunionized counterparts that could facilitate them earning above market average rents from the firms (Hirsh, 1991, 2008). Unions can put collective pressure or pose potential threat of strike to have the agreements written on their favorable terms (Hirsch, 2008). Thus firms might utilize their control in earnings reports to deal with strong bargaining power of unions. For example, DeAngelo and DeAngelo (1991) find that firms are more likely to report lower net income when negotiations with unions are on the way than the periods of non-negotiations. Bova (2013) finds that unionized firms tend to miss mean consensus analysts forecasts more often than nonunionized firms, whether there is a negotiation on place or not. Another way union can influence disclosure practices through encouragign of employing accounting conservatism or more timely disclosure of losses in earnings. While inflated earnings reports provide wrong directions to the unions in bargaining with employers, accounting conservatism is more favorable for both unions and employers. Essentially accounting conservatism would provide more accurate directions for the unions and better bargaining tools for the employers. Leung et al. (2009) find that firms are more likely to practice accounting conservatism when unions win elections and step in the table of negotiations. Farber et al. (2010) also find positive relation between the likelihood of accounting conservatism in disclosure 7

practices and the strength of unions. Chung et al. (2014), in a recent paper, find that managers tend to hide good news during the periods of negotiating with unions and prefer to publish such news once negotiations become completed. 2.2. Auditors concern of labor union activities and audit fees Besides requiring high quality corporate disclosure, unions also demand better quality of audit that can confirm that disclosed information is accurate and reliable. Also managers, with the concern of further auditing of current financial report in the future, might prefer to employ policy of truthful disclosure to avoid future scrutiny (Ball et al., 2012). On the other hand, managerial concern of dealing with union bargaining power might create incentive to control both quality and quantity of financial information to be disclosed to public as well as to unions. Prior literature argues that manager gain more control over financial report when audit quality is lower (e.g., Carcello and Nagy 2004; Francis and Yu 2009; Lennox and Pittman 2010; Reichelt and Wang 2010). Auditors deal three type of risks while engaging with clients, which are client business risk or the risk generated from the uncertainty in client s survival and financial performance, audit risk or the risk of auditor failing at addressing and modifying opinion on materially misstated financial statements, auditor business risk or the risk of incurring litigation costs and losing reputations from audit failure. The audit risk can be affected by both business risk and financial reporting risk of a client firm. Heninger (2001) finds that litigation risk of auditor is increasing with earnings management. Auditors face more likelihood of experiencing litigation when a client announces bankruptcy or incurs unexpectedly extreme losses (Rittenberg et al., 2012). 8

As we mention above that there is a large body of literature suggesting that labor unions have incentives not aligned with shareholders, which might create problems in implementing of value maximizing optimal decisions. A consequence of a firm s employing of suboptimal investment decisions because of bargaining with labor union could lead to a higher likelihood of litigation from shareholders and other stakeholders. Furthermore, such increase in business risk and litigation risk of client firm could increase litigation risk of the audit firm. Dispute between labor unions and management of the firms could be associated with two negative consequences that might jeopardize the auditors concern of litigation risk and reputational damage. First, labor unions could create credible threats of strikes and close downs of firms, which result in loss in reputation and high risk of litigation. Thus in the presence of dispute with labor unions, auditors might be highly concerned of client firms future performance and ability to survive. As auditors need to put greater effort in assessing of higher business risk underlying operational activities of client firms, they are more likely to charge higher audit fees. Second, labor unions have strong demand for fair disclosure of information so that they can negotiate with the firms effectively and earn appropriate wages. This pressure of fair disclosure created by unions might discourage the managers to publish inflated earnings reports. Rather to negotiate with unions with better terms, managers tend disclose bad news more timely, or adopt policies of accounting conservatism. However, presence of disputes with labor unions might indicate that unions have weak voices inside the firms and their needs are unfulfilled. As a result, the benefits of unions associated with demand of fair disclosure could more likely to be disappeared when there is a weak role of unions inside the firms. Thus auditors could charge higher audit fees where managers have disputes ongoing with labor unions. 9

Following above arguments, as we consider charges of unfair labor practices by unions against the employers in this paper, we can predict that such disputes would lead to higher audit fees, as these allegations indicate that there is hostile environment in the relationship between unions and the top management. So our main hypothesis is H1: Audit fees would be higher in the post-filing period of unfair labor practice charges than the pre-filing period. 3. Methodology and Data 3.1. Empirical Specification We use a multivariate regression model to test our hypothesis, where LN(AUDIT FEE) or the natural logarithm of audit fee paid to primary external auditor has been utilized as the dependent variable. The independent variable is the POST-CHARGE PERIOD or the period after filing of charges of unfair labor practices against an employer. Following is our main regression model LN(AUDIT FEE) = β 0 + β 1 POST CHARGE PERIOD + β 2 SIZE + β 3 TANGIBILITY + β 4 ROA + β 5 LOSS + β 6 BIG4 + β 7 FIRM AGE + β 8 AUDITOR TENURE + β 9 AUDITOR CAHNGE + β 10 LN(NON AUDIT FEE) + β 11 SPECIALIST + β 12 FISCAL YEAR END + β 13 UNQUALIFIED + β 14 RESTATEMENT + β 15 RECINV + β 16 REPORT LAG + β 17 GOING CONCERN + β 18 PUBIC EXCHANGE + β 19 LITIGATION INDUSTRY + β 20 NSEG + β 21 FOREIGN + Industry Indicators + Year Indicators + ε (1) 10

We provide detail of our variables in Appendix A. Each firm-year is our unit of analysis, so the variables are subject to subscript it (i denotes a firm and t denotes a year) that we suppress in the above model. We develop our model mainly following Simunic (1980) and prior literature (e.g., Hay et al., 2006; Gul and Goodwin, 2010; Chen et al., 2015). We control several client characteristics capturing inherent business complexity and risk. Higher business complexity requires greater auditor effort that could result in higher audit fees. For example, larger firms (SIZE), firms with special items (SPECIAL), higher proportion of sales from foreign segments (FOREIGN), greater number of business segments (NSEG) are in general more complex, and therefore are related with higher audit fees. Other important characteristics that we consider are associated with business risk. Firms with higher leverage (LEVERAGE), lower or negative profitability (ROA and LOSS), higher holdings of inventory and account receivables (RECINV) are tend to be highly risky and thus are likely to pay higher audit fees. Also younger companies (AGE) are tend be charged with higher audit fees. Audit risks and fees should be positively associated with going concern opinions (GOING CONCERN) and restatements (RESTATEMENT). We include audit report lag (REPORT LAG), or the number of days between signature date of audit opinion and the date of fiscal year end. Longer lag in reporting might indicate that auditors dealt with unexpected issues, or that auditors resolved concerns that management disagree with. Thus higher reporting lag could be associated with higher audit fees. We control for whether a firm s fiscal year ends at December (FISCAL YEAR END), which is a busy season because a large number of firms fiscal year end is the last month of the calendar year. So fiscal year end moth as December could be associated with higher audit fees. We control for whether firms are operating in high litigation industries (LITIGATION INDUSTRY), which is a proxy for litigation risk that 11

could result in higher audit fees. We define high litigation industries based on SIC 2833-2838, 3570-3577, 3600-3674, 5200-5961, 7370-7374, and 8731-8734 (Francis et al., 1994). We control for industry effects, where we use Fama-French 12 industry classification, and year effects. We perform each regression based on ordinary least squares (OLS), where t-statistics are heteroscedasticity roust and clustered at the industry-year level. 3.2. Sample We collect information of employee-initiated filing of charges against employers from the NLRB website. 3 Under the National Labor Relations Act of 1935, it is illegal for the employers to violate the employee rights of unionizing or conducting group activities. Employees have the rights to unionize or conduct group activities without any interruptions from the employers. The NLRB is the responsible organization to oversee and initiate legal proceedings of charges of unfair labor practices. 4 We first collect detail information of charge filing for the period of 2000 to 2009 of which audit related information is available in Audit Analytics and accounting information is available in Compustat. As either individual employees or unions can file unfair labor practice charges, we hand collect information of charged that are filed by unions. We consider the first filing date of charges in the sample period for each firm, in case of a firm experiencing multiple years of charges. We make sure that each firm has detail auditing and accounting information at least one year before and one year after the period of litigation, which can be extended up to maximum five years before and five years after the event. We also use 3 Information of employee-initiated lawsuit can be extracted from https://www.nlrb.gov/opengov/nlrb-data-datagov. 4 There are five types of unfair labor practices that had been made illegal by NLRA, a detail discussion of each type of practices is discussed in Appendix A. 12

Compustat segment files to collect information of business segments and sales from foreign segments. We exclude firms in financial (SIC between 6000 and 6999) or utilities (SIC between 4900 and 4999) industries. Satisfying all these requirements result in 1,055 firm-years observations for the period of 2000 through 2014, which has in total information of 145 unique firms. We provide detail description of our independent and control variables in Appendix A. We report distribution of sample by industry in panel A of table 1, whereas we use Fama- French 12 industry classification throughout analyses. 5 The distribution of industry membership of charged firms are not symmetric at all. Industry with largest number of firms in the sample are Manufacturing (28%), which is notably followed by Shops (19%) and Chemicals (11%). In panel B of table 1 we report sample distribution by filing year, which starts from 2001, even though our sample covers the period of 2000 to 2014, because we only allow the firms that have auditing and accounting information of at least 1 year before and 1 year after the charging year. The largest number of charged firms goes back to as early as the year of 2001 (23%), which is followed by 2002 (21%). One obvious trend we can observe that number of charged firms decreases over the years, which is mostly because of our sample that selects first filing date in the sample period as the charge year, whereas many firms might experience multiple lawsuit years in the later part of the period following the first event. Table 2 presents summary statistics of the variables for our analysis. We can observe that mean and median dollar values of audit fees in our sample are $2.72 million and $1.51 million, respectively, whereas upper quartiles and lower quartile dollar values of audit fees are $3.32 million and $0.70 million, respectively. Compared to audit fees, non audit fees are lower, which 5 Among 12 industries, 3 industries that are missing because of exclusion criterion or not having enough observation to be included sample are Telecommunication, Utilities, and Finance. 13

have mean and median dollar values as $1.23 million and $0.48 million, respectively. BIG4, which is the indicator variables of firms audited by one of the big 4 auditors, shows that on average more than 90% of firm-years are audited by big 4 auditors. Also the tenure of an audit firm servicing a client, measured by AUDITOR TENURE, is on average 17 years in the sample. Mean value of AUDITOR CHANGE, an indicator variable for firms changing auditor in a fiscal year, suggests that the likelihood of a firm s switching to the service of different auditor is 4% in the sample. 4. Results 4.1. Univariate Comparisons In table 3 we compare audit characteristics in pre-filing period with that of post-filing period. Before Charges contains observations with at least 1 year to maximum 5 years of pre-filing period. Similarly, After Charges contains observation with at least 1 year to maximum 5 years of post-period of unfair labor practice charges. As we can observe, mean value of audit fee after the charge filing is significantly higher than the mean value at pre-filing period. Also we can observe that report lag is higher and going concern opinion is more likely to take place in post-filing period. In table 4, we present the mean value of audit fees for each period before and after the filing of unfair labor practice charges. We can observe that, using whole of unfair practices, audit fees in million dollars are consistently higher in each period of post-filing of charges than each period of pre-filing of charges. Similar trend we can observe for subsamples based on each type of unfair labor practices. Most notable trend in the rise of audit fees following the filing of charges that we can observe is for the allegation of Refusal to Bargain, which is expected as unions file 14

this type of allegations against firms when employers refuse to cooperate with unions to come to an agreement. 4.2. Multivariate Analyses Table 5 shows the results from our initial regression analysis. Column (1) reports results using equation (1) without including year indicators, where we can observe that the period of post filing charge is significantly and positively associated with log audit fees. Essentially the value of the coefficient of POST-CHARGE PERIOD is 0.479 that is significant at 1% level. Once we control for year effects as in column (2), we can find that post filing period is still positive that is significant at 5% level. It suggests that auditors charge higher audit fees following the filing of charges of unfair labor practices against the client firms. For the control variables, in both column (1) and column (2), we can observe that firms that are larger, more levered, less tangible, more industrially diversified, and holding higher proportion of sales from foreign segments experience higher audit fees. We also find that audit fees are likely to be higher for the firms who are audited by Big 4 auditors, and auditors with longer tenure and are specialist the industry the client firms are operating in. Also firms with going concern opinion are charged with higher audit fees. Our results are consistent with main hypothesis that once a client firm experience unfair labor practice charges by its labor union, the audit firm charge audit fees than fees in the periods prior to the allegation. One important issue to notice in the table 1 that we pool all five types of unfair labor practices in the regression analysis, whereas it is reasonable to believe that auditors response to charges by union should not be similar across the types. For example, violation of 15

section 8a(1) or interference refers to activities that include threats and warnings issued to prevent workers from forming or joining group activities, which is the case more likely to happen at the beginning of disputes between firms and unions. On the other hand, two important violations that can seriously jeopardize a firm s relation with union are the violation of section 8a(3) or discrimination, and the violation of section 8a(5) or refusal to bargain with good faith. The former allegation arises when firms undertake disciplinary actions, such as suspending, discharging, relocating, or demoting employees because of their involvement in group or union activities. The latter allegation usually emerges when employers fail to provide information, become unwilling to meet and deal with union representatives, which could mean a direct confrontation with union in a more mature stage of disputes. Thus we can predict that allegations of discrimination and refusal to bargain could be a serious concern for the auditors. The remaining two allegations, domination under section 8a(2) and retaliation under section 8a(4) contain only 1.5% and 1.6% of observation in sample, respectively and thus lack enough observations to test based on subsamples. In table 6, we present our results of regression analysis on the subsample based on different types of unfair labor practices. In the column (1), we present the analysis using the firms that Interference as the unfair labor practice charge. We do not find any impact of the allegation of Interference on the audit fees, as the coefficient of POST-CHARGE PERIOD indicates, which is expected following the argument that auditors should be concerned of the type of labor disputes that are in mature stage and have the potential of creating considerable hostile environment in dealing with unions. In column (2), we use subsample of firms that experienced Discrimination as the type of unfair labor practice charge and present the results. We find that the coefficient of POST-CHARGE PERIOD is positive and highly significant, which implies that auditors are likely to charge higher 16

audit fees when a firm receives accusation of discriminating against its employers who are active in group or union related activities. Usually such accusations indicate that firms undertake disciplinary actions to control unions and thus the unions and top management of the firms are in real confrontation. We analyze the effect of the claims of Refusal to Bargain and present results in column (3). As we discussed earlier, unions file charges of Refusal to Bargain when employers do not want to negotiate directly or supply information anymore. This is the condition that could be created from highly hostile relation between the unions and employers. As expected, we find that audit fees are significantly associated with post period of charge filing. It implies that auditors consider the allegation of employers unwillingness to bargain with unions in a serious note. 4.3. Further Analysis: Difference-in-Differences Approach Our previous results can be led by unobservable changes over the period, such as industry shocks or changes in macroeconomy. We deal with this issue by doing further analysis based on a matched sample differences-in-difference approach. To construct matched control firms, first we focus on the firms that are available in Compustat and Audit Analytics but did not experience any unfair labor practice charges over the sample period. Then we match these control firms with charged firms by Fama-French 12 industry, sales revenue and ROA. For matching by sales, we select control firms that have sales figure falling within 10% of sales of the charged firms in the period prior to filing of charges. Similar approach has been applied to construct to match by ROA. On the occasion when we find multiple matched control firms for a single charged firms, we keep 17

all of them but remove the repeated control firms. Finally we estimate the following model pooling the charged and matched firms: LN(AUDIT FEE) = β 0 + β 1 CHARGED FIRMS AFTER CHARGE + γx + ε (2) where X represents all control variables that used in equation (1). CHARGED FIRMS is the dummy variable equals one (zero) for a firm charged (matched) firm, and AFTER CHARGE is dummy variable equals one after the period of unfair labor practice charges. Here β 1 measures the difference in audit fees specific to the filing of charges. Table 7 reports the results. In column, using whole sample of unfair labor practices, we find that the coefficient of CHARGED FIRMS AFTER CHARGE is positive and highly significant. Thus the results suggest that auditors charge higher audit fees after the firms become accused of unfair labor practices, in comparison with the matched control firms that have never been accused of committing such practices over the sample period. Next we employ this difference-in-differences approach for subsample based on major unfair labor practices. For each subsample, we use similar methodology to construct matched control sample that we apply for whole sample. In column (2) of table 7, we can find that allegation of Interference is not significantly associated with audit fees in the post-allegation period. Then we examine the allegations based on Discrimination and Refusal to Bargain in column (3) and column (4), respectively. Coefficients of CHARGED FIRMS AFTER CHARGE in both columns are positive and statistically significant. These results are consistent with what we find in previous tables. 18

5. Conclusion The paper examines how allegations of unfair labor practices against the employers would affect the audit fees charged by the auditors. The NLRA 1935 made it illegal for the firms to violate the employee rights of unionizations. Violation this rights could be result in filing of unfair labor practice charges to the NLRB. The NLRB is the responsible organization to initiate and conduct investigation and legal proceeding of such claims against the employers. We argue that auditors should consider the charges of unfair labor practices against their client firms negatively for multiple reasons. First, dispute with unions could turn out to be serious threats to the survival of the firms. Unions have strong bargaining power that they can use to put pressure on firm to come to their favorable terms. Such pressure of unions or the absence of agreement with unions could increase the litigation risk and future likelihood of serious reputational damage. Second, unions have positive role in encourage fair corporate disclosure. Essentially unionized firms are more likely to provide accurate earnings report or employ accounting conservatism than nonunionized firms. A weak voice of unions inside the firms could weaken such managerial incentives of fair corporate disclosure. Thus we can predict auditors would change audit fees when firms are in conflict with unions. Our empirical results confirm our prediction. Moreover, we find that types of unfair labor practices that auditors take in a most serious not is discriminating against employees because of their involvement in unionized activities, and refusal to bargain with good faith with union representative. 19

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Appendix A: Variable Description Variable Definition Unfair Labor Practices INTERFERENCE DOMINATION DISCRIMINATION RETALIATION REFUSAL TO BARGAIN Dummy variable equal to one if employees file charges against employer based on Section 8(a)(1) of NLRA, which is the Interference of employer in union or group activities. Dummy variable equal to one if employees file charges against employer based on Section 8(a)(2) of NLRA, which is the dominating activities of employer to control unions. Dummy variable equal to one if employees file charges against employer based on Section 8(a)(3) of NLRA, which is the discriminatory actions against employees who are involved in union or group activities. Dummy variable equal to one if employees file charges against employer based on Section 8(a)(4) of NLRA, which is the retaliation of employer for filing charges of unfair labor practices or collaborating with NLRB. Dummy variable equal to one if employees file charges against employer based on Section 8(a)(5) of NLRA, which is the refusal of employer to bargain in good faith with the representatives of union. Audit Characteristics LN(AUDIT FEE) LN(NON ADUIT FEE) BIG4 AUDITOR TENURE AUDITOR CHANGE SPECIALIST FISCAL YEAR END UNQUALIFIED RESTATEMENT REPORT LAG GOING CONCERN The natural logarithm of audit fees. Audit fees are the fees paid to primary external auditor for audit services. Source: Audit Analytics. The natural logarithm of nonaudit fees. Nonaudit fees are the fees paid to primary external auditor for nonaudit services. Source: Audit Analytics. BIG4 is a dummy variable equal to one if the auditing service of a firm is provided by one of the Big 4 auditors. Source: Audit Analytics and Compustat. The number of years the firm is audited by the current auditor. Source: Audit Analytics and Compustat. Dummy variable equal to one if the firm changes its auditor in the fiscal year. Source: Audit Analytics and Compustat. Dummy variable equal to one if the auditor of a firm is an industry specialist. An auditor is a specialist of an industry, which is defined by 2-digit SIC code, if it has the largest market share by the assets of clients in the industry. Source: Audit Analytics and Compustat. Dummy variable equal to one if December is the fiscal year end of a firm. Source: Compustat. Dummy variable equal to one if an unqualified opinion without any additional language is issued by the auditor (AUOP=1), and 0 otherwise. Source: Compustat. Dummy variable equal to one there is a restatement of a firm s financial statement. Source: Audit Analytics. Lag between the signature date of the audit opinion (SIG_DATE_OF_OP_S) and the date of the fiscal year-end (FISCAL_YEAR_END_OP). Source: Audit Analytics. Dummy variable equal to one if the auditor issues a going concern modified report, and 0 otherwise. Source: Audit Analytics. 24

Firm Characteristics SIZE LEVERAGE TANGIBILITY ROA LOSS FIRM AGE The natural logarithm of total assets of a firm. Source: Compustat. Leverage, which is defined as Long-term debt (DLTT)/total assets (AT). Source: Compustat. Tangibility, which is defined as property, plant, and equipment (PPENT)/total assets (AT). Source: Compustat. Return on assets, which is defined as net income (EBITDA)/total assets (AT). Source: Compustat. Loss is a dummy variable equal to one if ROA is negative. Source: Compustat. The number of years a firm is active publicly. Source: Compustat. RECINV Receivable and inventory ratio, which is defined as (accounts receivable (RECT) + inventory (INVT))/total assets (AT). Source: Compustat. LITIGATION INDUSTRY PUBLIC EXCHANGE Dummy variable equal to 1 if the firm is in high-litigation industry, and 0 otherwise. High-litigation industries are those with SIC codes 2833-2838, 3570-3577, 3600-3674, 5200-5961, 7370-7374, and 8731-8734. Source: Compustat. Dummy variable equal to one if the firm is a public company included in a major exchange (STKO=0), and 0 otherwise. Firms coded with 0 are either subsidiary entities of the public firms or are not traded on any one of the major exchanges. Source: Compustat. NSEG Number of business segments of a firm. A business segment is defined by unique 4- digit SIC industry a firm is operating in. Source: Compustat Segment Files. FOREIGN Proportion of sales by foreign segments. Source: Compustat Segment Files. Other Control Variables Industry indicators Year indicators Indicator variables for Fama-French 12 industries. Source: Compustat. Indicator variables for fiscal-years. Source: Compustat. 25

Table 1: Sample Distribution Panel A: Distribution of sample by industry Industry Number of Firms % of Total Consumer Non-Durables 17 12% Consumer Durables 7 5% Manufacturing 41 28% Energy 8 6% Chemicals 16 11% Business Equipment 10 7% Shops 28 19% Healthcare 6 4% Other 12 8% Panel B: Sample distribution by year of unfair labor practice charges Filing Year of Charges Number of Firms % of Total 2001 34 23% 2002 31 21% 2003 16 11% 2004 16 11% 2005 16 11% 2006 11 8% 2007 11 8% 2008 4 3% 2009 6 4% Panel A of this table present sample distribution by industry, where industry is defined following Fama-French 12 industry classification. Panel B presents sample distribution of the calendar year the unfair labor practice charges were filed. 26

Table 2: Summary Statistics Variable N Mean STD Lower Median Upper Quartile Quartile LN(AUDIT FEE) 1,055 14.197 1.133 13.460 14.227 15.015 LN(NON ADUIT FEE) 1,055 13.029 1.463 12.170 13.082 13.999 AUDIT FEE ($ million) 1,055 2.717 3.833 0.701 1.509 3.317 NON AUDIT FEE ($ million) 1,055 1.225 2.860 0.193 0.480 1.202 SIZE 1,055 7.525 1.445 6.576 7.545 8.367 LEVERAGE 1,055 0.222 0.195 0.095 0.199 0.303 TANGIBILITY 1,055 0.310 0.176 0.172 0.274 0.423 ROA 1,055 0.147 0.072 0.101 0.139 0.186 LOSS 1,055 0.014 0.118 0.000 0.000 0.000 BIG4 1,055 0.911 0.285 1.000 1.000 1.000 FIRM AGE 1,055 37.622 18.354 20.000 35.000 54.000 AUDITOR TENURE 1,055 17.076 16.729 4.000 10.000 26.000 AUDITOR CHANGE 1,055 0.039 0.193 0.000 0.000 0.000 SPECIALIST 1,055 0.248 0.432 0.000 0.000 0.000 FISCAL YEAR END 1,055 0.607 0.489 0.000 1.000 1.000 UNQUALIFIED 1,055 0.469 0.499 0.000 0.000 1.000 RESTATEMENT 1,055 0.136 0.343 0.000 0.000 0.000 RECINV 1,055 0.309 0.139 0.216 0.298 0.388 REPORT LAG 1,055 57.932 45.924 43.000 55.000 63.000 GOING CONCERN 1,055 0.020 0.140 0.000 0.000 0.000 PUBLIC EXCHANGE 1,055 0.908 0.289 1.000 1.000 1.000 LITIGATION INDUSTRY 1,055 0.246 0.431 0.000 0.000 0.000 NSEG 1,055 2.094 1.110 1.000 2.000 3.000 FOREIGN 1,055 0.256 0.279 0.000 0.170 0.438 INTERFERENCE 1,055 0.472 0.499 0.000 0.000 1.000 DOMINATION 1,055 0.015 0.122 0.000 0.000 0.000 DISCRIMINATION 1,055 0.297 0.457 0.000 0.000 1.000 RETALIATION 1,055 0.016 0.126 0.000 0.000 0.000 REFUSAL TO BARGAIN 1,055 0.609 0.488 0.000 1.000 1.000 This table present summary statistics of the variables. Definitions and sources of variables are presented in Appendix A. 27

Table 3: Audit Characteristics Before and After Filing of Charges Before Charges After Charges Difference Variable Mean Median Mean Median Mean AUDIT_FEES ($million) 1.834 0.858 3.239 2.000-1.405*** NON AUDIT FEES ($million) 1.677 0.686 0.957 0.400 0.720*** BIG4 0.857 1.000 0.943 1.000-0.086*** AUDITOR CHANGE 0.051 0.000 0.032 0.000 0.019 AUDITOR TENURE 16.240 9.000 17.570 11.000-1.330 SPECIALIST 0.204 0.000 0.275 0.000-0.070*** UNQUALIFIED 0.592 1.000 0.397 0.000 0.195*** RESTATEMENT 0.140 0.000 0.134 0.000 0.006 REPORT LAG 49.316 45.000 63.026 58.000-13.709*** GOING CONCERN 0.008 0.000 0.027 0.000-0.019*** This table presents mean and median of audit characteristics, and the differences between the mean of before charges and the mean of after charges. Before Charges contains at least 1 year to maximum 5 years of observations before the charge filing period, similarly After Charges contains at least 1 year to maximum 5 years of observations after the charge filing period. The mean differences is calculated using t-test. *, **, *** denote statistical significance at 10%, 5%, and 1% levels, respectively. Definitions and sources of variables are presented in Appendix A. 28

Table 4: Mean Audit Fees in the Years before and after the Period of Charge Filing Before and Whole Interference Domination Discrimination Retaliation Refusal to After Sample Bargain -5 1.560 1.908 0.600 0.606 1.544 1.127-4 1.549 1.943 0.604 0.805 2.001 1.169-3 1.968 2.137 0.716 1.294 1.829 1.604-2 1.959 2.079 0.751 1.513 1.815 1.632-1 1.863 1.836 0.996 1.684 2.101 1.808 1 2.397 2.086 0.980 2.228 1.995 2.626 2 2.947 2.906 1.595 2.900 2.802 3.127 3 3.481 3.505 2.252 3.534 3.020 3.823 4 3.677 3.908 2.388 3.567 2.994 3.931 5 3.886 3.992 2.564 3.501 4.255 4.251 This table presents mean audit fees ($ million) in the years before and after filing of unfair labor practices charges against employers. Whole sample contains observations with all five types of charges under section 8a of NLRA. Interference, Domination, Discrimination, Retaliation, and Refusal to Bargain contain only observations of firms that experience unfair labor practice charges on section 8a(1), section 8a(2), section 8a(3), section 8a(4), section 8a(5) of NLRA, respectively. Definitions and sources of variables are presented in Appendix A. 29

Table 5: Charges of Unfair Labor Practices and Audit Fees Dependent Variable: LN(AUDIT FEE) (1) (2) POST-CHARGE PERIOD 0.479*** (9.510) 0.090** (2.410) SIZE 0.498*** (29.410) 0.429*** (29.260) LEVERAGE 0.651*** (6.860) 0.589*** (6.620) TANGIBILITY -1.001*** (-9.300) -0.691*** (-6.410) ROA 0.444** (2.000) 0.248 (1.280) LOSS 0.232 (1.340) 0.182 (1.310) BIG4 0.333*** (5.300) 0.306*** (4.700) FIRM AGE 0.002* (1.930) 0.003*** (2.890) AUDITOR TENURE -0.005*** (-5.240) -0.005*** (-5.880) AUDITOR CHANGE -0.153* (-1.720) -0.035 (-0.460) LN(NON AUDIT FEE) 0.027* (1.790) 0.103*** (7.860) SPECIALIST -0.087*** (-2.600) -0.053** (-2.040) FISCAL YEAR END 0.017 (0.410) 0.026 (0.680) UNQUALIFIED -0.110*** (-2.510) -0.066** (-1.940) RESTATEMENT -0.098 (-1.290) -0.030 (-0.550) RECINV 0.133 (0.890) 0.130 (1.000) REPORT LAG 0.002* (1.910) 0.001 (1.560) GOING CONCERN 0.526*** (3.070) 0.551*** (3.000) PUBLIC EXCHANGE 0.203*** (2.750) 0.205*** (2.670) LITIGATION INDUSTRY -0.115** (-2.230) -0.057 (-1.420) NSEG 0.079*** (4.410) 0.091*** (5.660) FOREIGN 0.732*** (12.010) 0.665*** (10.450) Industry indicators Yes Yes Year indicators No Yes N 1,055 1,055 Adj R 2 0.795 0.858 This table presents regression results for the relation between audit fees and the periods after filing of unfair labor practices charges against employers. The regressions use OLS, t-statistics are based on heteroscedasticity robust and industry-year level clustered standard errors and are reported in the parentheses. Industry indicators are based on Fama-French 12 industry classification. Constant terms are included but not reported. *, **, *** denote statistical significance at 10%, 5%, and 1% levels, respectively. Definitions and sources of variables are presented in Appendix A. 30

Table 6: Types of Unfair Labor Practices and Audit Fees Dependent Variable: LN(AUDIT FEE) Interference (1) Discrimination (2) Refusal to Bargain (3) POST-CHARGE PERIOD 0.000 (0.000) 0.151*** (2.590) 0.179*** (4.760) SIZE 0.483*** (18.190) 0.363*** (8.550) 0.456*** (19.870) LEVERAGE 0.438*** (3.580) 0.504*** (3.830) 0.662*** (5.460) TANGIBILITY -0.496*** (-3.230) -0.197 (-1.130) -0.854*** (-5.200) ROA 0.316 (1.470) -0.362 (-1.090) 0.504 (1.560) LOSS -0.081 (-0.550) -0.063 (-0.330) 0.036 (0.220) BIG4 0.111 (1.550) 0.246*** (2.700) 0.319*** (3.170) FIRM AGE 0.001 (0.540) 0.008*** (3.980) 0.003** (2.300) AUDITOR TENURE -0.004** (-2.480) -0.005*** (-2.690) -0.006*** (-5.440) AUDITOR CHANGE -0.073 (-0.760) -0.077 (-0.450) -0.101 (-1.040) LN(NON AUDIT FEE) 0.090*** (5.330) 0.082*** (2.720) 0.073*** (2.620) SPECIALIST -0.118*** (-2.7700 0.102* (1.730) -0.028 (-0.810) FISCAL YEAR END 0.075 (1.430) 0.384*** (3.950) 0.068 (1.210) UNQUALIFIED -0.159*** (-3.910) -0.176 (-2.720) 0.023 (0.510) RESTATEMENT -0.144** (-2.280) -0.154** (-2.060) 0.045 (0.640) RECINV 0.426* (1.870) -0.706* (-1.940) 0.152 (0.890) REPORT LAG 0.003** (2.370) 0.002* (1.760) 0.001*** (1.220) GOING CONCERN 0.302 (1.440) -0.047 (-0.240) 0.780*** (3.280) PUBLIC EXCHANGE 0.038 (0.430) 0.116 (1.400) 0.309*** (3.170) LITIGATION INDUSTRY -0.257*** (-4.150) -0.497*** (-3.730) 0.146*** (3.230) NSEG 0.091*** (4.220) 0.094*** (2.540) 0.071*** (4.060) FOREIGN 0.761*** (7.300) 1.072*** (7.120) 0.460*** (4.840) Industry Indicators Yes Yes Yes Year Indicators Yes Yes Yes N 498 313 643 Adj R 2 0.889 0.897 0.859 This table presents regression results for the relation between audit fees and the periods after filing of unfair labor practices charges against employers. Each column shows results using subsample based on the type of charges was filed. The regressions use OLS, t-statistics are based on heteroscedasticity robust and industry-year level clustered standard errors and are reported in the parentheses. Industry indicators are based on Fama-French 12 industry classification. Constant terms are included but not reported. *, **, *** denote statistical significance at 10%, 5%, and 1% levels, respectively. Definitions and sources of variables are presented in Appendix A. 31