The effect of tenure on auditor realization rates

Abstract

Purpose

The purpose of this study is to test whether the realization rate on audit engagements increases with auditor tenure in competitive markets, suggesting the presence of initial audit lowballing.

Design/methodology/approach

Using regression analysis, we test this hypothesis with fee- and cost-related data from a sample of local governments audited by a single audit firm. Based on representations of the firm, we classify the audit market for the 127 cities, counties and school districts in our sample as competitive and the audit market for the 93 special district audits as non-competitive.

Findings

As hypothesized, we find that in the competitive market, the realization rate on audit engagements increases with auditor tenure but does not do so in the non-competitive audit market.

Research limitations/implications

We cannot identify the specific engagements which were subject to a competitive bidding process, so we rely on the auditor’s representation of competitiveness by entity type.

Originality/value

To our knowledge, the central prediction of audit pricing models that the auditor’s realization rate increases with auditor tenure has not been tested in real audit markets because proprietary cost data are rarely available. Testing this prediction is the primary contribution of this paper.

Citation

Johnson, L. and O'Keefe, T.B. (2015), "The effect of tenure on auditor realization rates", Managerial Auditing Journal, Vol. 30 No. 3, pp. 206-225. https://doi.org/10.1108/MAJ-06-2014-1046