Audit Partner Tenure and Cost of Equity Capital

Abstract

SUMMARY We examine whether audit engagement partner tenure and rotation affect investors' perceptions, as proxied by the ex ante cost of equity capital. We find that partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements, and that the imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor. Consistent with the tenure results, we also find that partner rotation is associated with increased ex ante cost of equity capital. Our results are very robust to a variety of sensitivity tests and raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner's identity or pay attention to audit partner tenure; if investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure. JEL Classifications: M42; M48. Data Availability: The data used are from public sources identified in the manuscript.

Auditor Size and the Cost of Equity Capital over Auditor Tenure

“…Azizkhani, Monroe and Shailer () use a sample of Australian firms to investigate the association between the cost of equity capital and both audit firm and audit partner tenure. With respect to audit firm tenure, the authors find a nonlinear association between auditor tenure and the cost of equity capital for non‐Big 4 auditors, whereby perceptions of audit quality initially improve over tenure and then begin to deteriorate after approximately 10.7 years (Azizkhani et al ., ). The authors find no association between audit firm tenure and the cost of equity capital for Big 4 auditors.…”

“…First, Azizkhani et al . () utilize Australian data and examine a relatively small sample of observations during a time period that was primarily before the accounting scandals in the early 2000s. We utilize a much larger sample of observations from the United States and our sample period extends from 2003 to 2010.…”

“…Lastly, we examine the impact of auditor industry specialization on the cost of equity capital disparity over tenure, while Azizkhani et al . () do not consider specialization.…”

Audit partner busyness and cost of equity capital

“…Azizkhani et al () found a U‐shaped relationship between audit partner tenure and the cost of equity capital. They showed that the cost of equity capital decreases up to a threshold year, and then increases as the audit partner tenure increases.…”

Economic Consequences of Implementing the Engagement Partner: Signature Requirement in the UK

“…3 Studies use the EP identification to document that individual engagement partners' tenure and rotation are related to perceived audit quality (e.g., Azizkhani, Monroe, and Shailer 2013;Lennox, Wu, and Zhang 2014). The researchers suggest that mandatory rotation of engagement partner leads to higher quality audits in the years immediately surrounding rotation.…”