A well-educated workforce pays off in high-quality financial reporting

Andrew Call, associate professor of accounting researched whether having good employees throughout the company could matter in warding off or catching companies' financial-reporting problems before they could occur.

Every company says it wants to hire good employees. That should be more than a platitude, new research shows: Companies that have a well-educated workforce available in their headquarters' cities do a better job of accurately reporting and forecasting financial results than companies that must pull headquarters employees from a less-educated workforce.

Andrew Call, associate professor of accounting, studies the role employees play as whistleblowers after fraud has occurred in companies. For this research, he and colleagues from three other universities wondered whether having good employees - not just in accounting but throughout the company - could matter in warding off or catching companies' financial-reporting problems before they could occur.

"Your employees are the ones generating this information at its very core, and it gets funneled up through the organization to give the executives either reliable information to work with or not-so-reliable information," Call says. "The whole idea is that if employees who are making the sausage are better employees, the information they produce and funnel up through the system will be better."

Other researchers have explored the impact senior executives have on financial reporting, Call says, but few have looked at the impact midlevel managers and rank-and-file employees have. He and his colleagues were curious to answer the broader question of whether these everyday employees matter in accounting outcomes.

Call's team theorized that better-educated employees at company headquarters - where accounting and other key staff typically work - could make fewer errors in gathering and reporting the information that goes into financial reports. Better-educated workers also could be more likely to spot abnormal or potentially fraudulent transactions before they could go into those reports.

The whole idea is that if employees who are making the sausage are better employees, the information they produce and funnel through the system will be better. 

— Andrew Call

The researchers looked at two main categories of financial reporting: mandatory reporting and voluntary disclosures. For mandatory reporting, they examined whether to check on how the quality of employees affects the quality of the earnings information that public companies are required to disclose. For voluntary disclosures, they were interested to learn whether employee quality affects the quality of earnings forecasts companies choose to make. They also wanted to see whether employee quality relates to the frequency with which companies later restate earnings.

Because firm-by-firm data on employee quality is limited, Call's team turned to what they saw as the next best thing. Figuring that company headquarters and operations would pull employees from the local labor force, they used U.S. Census data on the average education levels of the workforces in 261 Metropolitan Statistical Areas where company headquarters or operations are located. The most-educated cities include college towns and large cities, for example, while less-educated cities include economically hard-hit, high-poverty areas.

The researchers then compared the education levels to the quality of accounting and financial statements the companies issued between 2005 and early 2012. Among the accounting measures examined, was the quality of accruals, which captures differences between when the company reports a transaction as earnings and when it is realized as cash. Accrual quality, Call notes, depends on whether transactions turn into cash in a reasonable amount of time.

The research found that companies headquartered in metropolitan areas with higher workforce education levels performed better on mandatory reporting measures - showing higher quality of accruals, fewer violations of internal control deficiencies, and fewer restatements of financial statements - than companies headquartered in areas with lower education levels. The firms in the better-educated areas also performed better on voluntary reporting measures, issuing timelier and more accurate earnings forecasts than firms in less-educated areas.

The importance of better-educated headquarters employees also held up when Call's team looked at firms that had moved their headquarters from one city to another. Firms that moved from areas of low education levels to those with higher levels showed improvements in the quality of their financial reporting, but those that moved from higher education to lower education levels saw their reporting quality decline.

Call's team also looked at the relationship between workforce education levels in companies' non-headquarters locations and the quality of the companies' financial reporting. That relationship was not as strong in other locations where the company has a presence as it is at headquarters, but the researchers note that not all firms disclose every location in which they operate, and how to weight the importance of each non-headquarters location is unclear. Because non-headquarters employees also contribute information that funnels and ultimately makes its way to employees at the headquarters, the researchers believe employee quality at these other locations could still play a role in quality financial reporting and the companies' overall financial picture.

Having high-quality accounting matters, Call says, because it can reduce auditing fees and the cost of capital, and because high-quality reporting benefits investors who value transparent, useable information. His team's research means companies shouldn't overlook the positive effect an educated workforce has on the quality of financial reporting.

"We can't think these employees are totally interchangeable," Call says. "Their impact is more important than that. They can add value in ways we might not even be thinking about."