Audit‐Firm Tenure and the Quality of Financial Reports*

Abstract

This study examines whether the length of the relationship between a company and an audit firm (audit‐firm tenure) is associated with financial‐reporting quality. Using two proxies for financial‐reporting quality and a sample of Big 6 clients matched on industry and size, we find that relative to medium audit‐firm tenures of four to eight years, short audit‐firm tenures of two to three years are associated with lower‐quality financial reports. In contrast, we find no evidence of reduced financial‐reporting quality for longer audit‐firm tenures of nine or more years. Overall, our results provide empirical evidence pertinent to the recurring debate regarding mandatory audit‐firm rotation — a debate that has, to date, relied on anecdotal evidence and isolated cases.

Is the SEC captured? Evidence from comment-letter reviews

“…As Big 4 auditors are generally considered higher quality than non-Big 4 auditors (DeFond 1992;DeFond et al 2016;Palmrose 1988), clients of the Big 4 may be less likely to violate GAAP. As an additional auditor characteristic, we include auditor tenure, Auditor_Tenure, which could be associated with higher reporting quality due to auditor learning or lower reporting quality if auditor independence is compromised (Geiger and Raghunandan 2002;Johnson et al 2002;Myers et al 2003). We differentiate between auditor changes initiated by the client, Auditor_Dismissed, and those initiated by the auditor, Auditor_Resigned, to control for their potentially varying effects on our dependent variables.…”

Audit Quality and Earnings Management in the Tunisian Context

“…Several prior studies document that a higher auditor quality (auditor size, industry specialization and tenure) mitigate the accruals earnings management (Becker et al 1998;Johnson et al 2002;Krishnan 2003;Balsam et al 2003;Myers et al 2003). But, fewer researches indicate that the higher audit quality enhance the real earnings management.…”

“…Furthermore, empirical evidence on audit quality measures has been mixed. For example, while many existing studies show that the use of brand name (Big N) auditors reduces earnings management (Becker et al, 1998;Francis et al, 1999;Lim and Tan, 2009) many other studies show that industry specialist auditors and short tenure of audit have the abilities and incentives to detect and constrain accounting-based earnings management (Krishnan, 2003;Riechelt and Wang, 2010;Ahsen, 2011;Johnson et al, 2002).…”

Auditor Tenure and Stock Price Volatility: The Moderating Role of Auditor Industry Specialization

“…Johnson et al (2002) also showed that discretionary accruals during the early years of auditing tenure are higher than towards the end of an auditor's tenure. Walker et al (2001) also concluded that the audit failure rate is less wherever there is a long connection between auditor and employer.…”