Financial Reporting Quality, Turnover Risk, and Wage Differentials: Evidence from Worker-level Data

We examine whether financial reporting quality influences employee turnover and wages using employer-employee matched data in the U.S. We find that low financial reporting quality is associated with high employee turnover risk, so workers demand wage premiums to bear this risk. High corporate governance firms exhibit a weaker association between financial reporting quality and turnover rates, suggesting that corporate governance mitigates turnover risk related to low financial reporting quality. We further find that more educated and higher paid workers receive higher wage premiums associated with low financial reporting quality although turnover rates are similar across these different groups of workers, consistent with sophisticated workers identifying financial reporting quality. Using Sarbanes-Oxley mandated reports of internal control weaknesses as a research setting, we show that as a firm’s internal control system weakens, firms pay wage premiums to employees. Overall, these analyses indicate that low financial reporting quality firms compensate for higher turnover risk by paying higher wages to workers, which increases firms’ cost of labor.