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Article
Publication date: 1 September 2022

Li (Lily) Zheng Brooks, Susan Gill, Bernard Wong-On-Wing and Michael D. Yu

This study aims to examine the moderating effect of audit firm tenure on the association between corporate social responsibility (CSR) and firm value. Prior studies…

Abstract

Purpose

This study aims to examine the moderating effect of audit firm tenure on the association between corporate social responsibility (CSR) and firm value. Prior studies provide mixed results on this association, which may be due to differing theoretical expectations related to CSR and firm value. It is also possible that external stakeholders are unable to differentiate between positive and negative CSR investments, as CSR reports are generally not assured by independent third parties. Thus, the authors propose that audit firm tenure may be used by external stakeholders to evaluate CSR performance.

Design/methodology/approach

The authors use an ordinary least squares regression to examine the moderating effect of audit firm tenure on the relation between CSR and firm value after controlling for other determinants of firm value and various internal and external governance mechanisms documented in the literature. The sample consists of 15,707 firm-year observations from US firms during the sample period of 2000 to 2012. The authors measure CSR quality using rating scores from MSCI ESG STATS (formerly the KLD database), audit firm tenure as the number of years the incumbent auditor has served the client and firm value using Tobin’s Q.

Findings

The results indicate that CSR is positively associated with firm value when audit firm tenure is long but not when tenure is short. The results are robust to alternative measures of firm value, CSR performance scores, and individual CSR dimensions. The evidence supports the argument against mandatory audit firm rotation in the USA.

Research limitations/implications

Future studies could examine a similar issue in alternative settings and/or look at cross-sectional variations among firms on the association between CSR and firm value by other auditor traits such as auditor industry specialization and big-name reputation. Additionally, as auditor alone is unable to ensure the quality of management disclosures and their accountability, future studies could examine the moderating effect of internal and other external governance mechanisms on the association between CSR and firm value, exploring when the signaling effect of auditor tenure on CSR reporting quality and its effect on firm value is most salient.

Practical implications

The findings are important to regulators and investors. The authors provide evidence that longer audit tenure serves as a signaling device for external investors with regard to the quality of a firm’s CSR performance. Hence, the study facilitates regulators’ cost-benefit analysis related to mandating audit firm rotation. The evidence suggests that mandating a term limit on auditor tenure may have the unintended consequence of eliminating a signaling effect of auditor tenure on the quality of CSR disclosures under information asymmetry. This supports the Public Company Oversight Board’s decision to forgo the requirement of mandatory audit firm rotation in the USA.

Originality/value

Prior literature presents mixed findings on the association between CSR performance and firm value based on a variety of underlying theories (economic, stakeholder and contingency theory). Literature on mandatory auditor rotation has concentrated on the auditor tenure effect on perceived and actual audit quality as reflected in earnings quality. Relying on agency theory, this study posits that auditor tenure serves as a signal for the quality of CSR activities in the absence of CSR assurance reporting as CSR quality can be difficult to evaluate. The authors provide evidence that audit tenure moderates the association between CSR activities and firm value and longer audit tenure makes it more likely that the CSR activities are associated with increased firm value.

Details

Managerial Auditing Journal, vol. 37 no. 8
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 17 August 2021

Qiliang Liu, Lei Zhao, Li Tian and Jian Xie

This paper aims to investigate whether close auditor-client relationships affect audit quality over the tenure of the audit partner and the potential role of partner…

Abstract

Purpose

This paper aims to investigate whether close auditor-client relationships affect audit quality over the tenure of the audit partner and the potential role of partner rotation in mitigating this effect.

Design/methodology/approach

Using the Chinese mandatory audit partner rotation setting, the authors identify the existence of a close auditor-client relationship if the audit partner tenure with a client is larger than the audit firm tenure with that client. The sample period (1998–2009) is divided into voluntary and mandatory rotation periods when examining the effects of audit partner tenure on audit quality for the normal and close auditor-client relationship subsamples, respectively. The authors also conduct a propensity score matching analysis to address a selection issue.

Findings

The paper finds that under the voluntary partner rotation regime, audit quality decreases with audit partner tenure for the subsample with close auditor-client relationships, whereas this effect is not shown in the normal relationship subsample. However, audit quality no longer declines with audit partner tenure under the mandatory partner rotation regime.

Originality/value

This is the first study that directly examines the effect of audit partner tenure on audit quality associated with close auditor-client relationships under the voluntary and mandatory partner rotation regimes.

Details

Managerial Auditing Journal, vol. 36 no. 6
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 3 August 2021

Nemiraja Jadiyappa, L. Emily Hickman, Ram Kumar Kakani and Qambar Abidi

The Indian Companies Act 2013 mandated auditor rotations in the financial year 2018–2019. Similar regulations are being considered in many countries, based on the…

Abstract

Purpose

The Indian Companies Act 2013 mandated auditor rotations in the financial year 2018–2019. Similar regulations are being considered in many countries, based on the assumption that longer tenure is detrimental to audit quality; yet, the evidence from investigations of this assumption is inconclusive. This paper aims to examine the effect of moderating factors on the relation between audit quality and audit tenure, given the regulatory trend and the lack of consensus in extant literature.

Design/methodology/approach

This paper examines the relationship between audit quality and audit tenure among Indian firms from 2001 to 2015 and tests for moderating factors including auditor compensation, business group affiliation and chief executive officer (CEO) duality.

Findings

Contrary to the objective of mandatory rotations, this study finds that longer auditor tenure generally enhanced audit quality among Indian firms prior to mandatory rotations. However, for companies paying abnormally high compensation to auditors, this paper finds that longer tenure decreases audit quality, particularly if the firm is affiliated with a business group or firms where the CEO also serves as the board chair. Thus, the potential benefits of mandated shorter tenure appear to be confined to high-fee paying companies with a business group affiliation and/or a dual-role CEO.

Originality/value

This study is one of the first to examine conditioning factors that affect the relationship between audit quality and auditor tenure. Results suggest that regulations limiting auditor tenure would be beneficial only to the shareholders of a narrow group of firms; while for the majority of firms, limiting auditor tenure may actually be counter-productive.

Details

Managerial Auditing Journal, vol. 36 no. 5
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 1 March 2011

Rana Ahmad Baker and Ali Al‐Thuneibat

The purpose of this paper is to investigate the relation between audit firm tenure and the perceived audit quality measured by the client‐specific equity risk premium. The…

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Abstract

Purpose

The purpose of this paper is to investigate the relation between audit firm tenure and the perceived audit quality measured by the client‐specific equity risk premium. The study population consists of all the manufacturing and service firms traded in Amman Bourse during the period 2002‐2005.

Design/methodology/approach

The Boone et al. model – with some modifications – was used for testing the hypotheses.

Findings

The results show that the relation between audit firm tenure and equity risk premium is positive, the equity risk premium increases with tenure as a result of reduced audit quality. These results were consistent with some previous studies, which showed that long relationships between an audit firm and a client are associated with lower perceived audit quality and, as a result, higher equity risk premium.

Practical implications

The audit firm should be rotated in order to enhance auditor independence and audit quality, and increase investors' confidence in reported earnings. Additionally, investors are encouraged to give higher attention to the tenure of the audit firm when evaluating the quality of the financial reports of the companies they are planning to invest in.

Originality/value

This is the first paper to provide evidence from a developing country about an important issue – audit quality – which is expected to support and sustain improvement of audit quality, and therefore, financial reporting quality.

Details

International Journal of Accounting & Information Management, vol. 19 no. 1
Type: Research Article
ISSN: 1834-7649

Keywords

Article
Publication date: 27 May 2014

Mai Dao and Trung Pham

This paper aims to examine the association between audit firm tenure and audit report lag (ARL) and the impact of auditor industry specialization on the association…

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Abstract

Purpose

This paper aims to examine the association between audit firm tenure and audit report lag (ARL) and the impact of auditor industry specialization on the association between audit firm tenure and ARL.

Design/Methodology/Approach

Using Habib and Bhuiyan’s (2011) method of measuring auditor industry specialization, the authors examine the sample of 7,291 firm-year observations from 2008 to 2010.

Findings

The authors find that auditor industry specialization (regardless of city-level, national-level and joint city- and national-level industry specialization) weakens the positive association between ARL and short audit firm tenure, suggesting that auditor industry specialization complements the negative effect of short audit firm tenure on ARL.

Originality/value

First, the authors add to the literature by answering the question of whether hiring industry auditor specialists is an effective way to shorten ARL created by short audit tenure. The authors provide some evidence that the concern of short audit tenure leading to longer ARL is reduced by hiring an industry-specialized auditor. Prior research mainly focuses on identifying the determinants of ARL without going further to find out which are the effective ways to reduce the audit delay. Second, their findings can somehow resolve the debate on whether audit firm rotation should be mandatory. A new auditor’s lack of knowledge of clients’ business operations during the early years of audit engagements results in longer ARL, which eventually influences the clients’ financial performance. The authors' result suggests the firms can reduce this adverse consequence by hiring an industry-specialized auditor. Finally, their findings may provide helpful information to firms in selecting external auditors, public accounting firms in selecting a differentiation strategy and regulators in mandating audit firm rotation.

Details

Managerial Auditing Journal, vol. 29 no. 6
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 13 May 2020

Henri Akono

This paper aims to examine how compensation committees perceive audit quality as indicated by audit firm tenure. Using the contracting weight attached to earnings and cash…

Abstract

Purpose

This paper aims to examine how compensation committees perceive audit quality as indicated by audit firm tenure. Using the contracting weight attached to earnings and cash flows in chief executive officer (CEO) compensation as proxy for the compensation committee’s perception of audit quality, the study examines whether compensation committees perceive performance metric informativeness as being affected by auditor tenure.

Design/methodology/approach

The paper regresses CEO cash compensation on accounting-based performance metrics and on interactions between auditor tenure and accounting-based performance metrics while controlling for other factors previously shown to affect CEO pay. Auditor tenure is measured using continuous and dichotomous variables.

Findings

Auditor tenure is associated with a reduced (positive) weight on earnings (operating cash flows), which suggests lower perceived audit quality as tenure lengthens consistent with the auditor closeness argument. This relation is asymmetric, i.e. the negative effect of longer auditor tenure on incentive contracting is more pronounced for positive earnings. The results are robust to using CEO total compensation as the compensation measure, as well as using level and change specifications.

Research limitations/implications

The inability to control for audit partner tenure in assessing the effect of audit firm tenure on incentive contracting and the potential endogeneity between auditor tenure choice and incentive contracting are the main limitations of this study. Given the lack of information on US audit partner tenure, the study could not control for the audit partner tenure issue. However, the study has attempted to mitigate the endogeneity issue by using a Heckman selection model that includes in the first-stage a regression of auditor tenure on various firm, performance measure and CEO-related governance characteristics, based on existing models (Li et al., 2010).

Practical implications

Compensation committees view auditor tenure as an indicator of accounting quality in setting CEO pay. Further, long auditor tenure is perceived as detrimental to financial reporting integrity, particularly when earnings numbers suggest positive managerial performance and innovations.

Originality/value

This study provides empirical evidence that auditor tenure matters in setting executive pay. Further, this study shows evidence on the link between auditor tenure and audit quality from an internal user’s perspective. Prior studies have focused either on external users (investors, creditors) or on the preparer (using measures such as discretionary accruals or meet/beat analysts’ forecasts or forecast guidance).

Details

Review of Accounting and Finance, vol. 19 no. 3
Type: Research Article
ISSN: 1475-7702

Keywords

Article
Publication date: 6 June 2016

Laura K. Rickett, Anastasia Maggina and Pervaiz Alam

This study aims to examine the relationship between auditor tenure and conservatism for firms in Greece. Greece not only has a high incidence of earnings management but is…

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Abstract

Purpose

This study aims to examine the relationship between auditor tenure and conservatism for firms in Greece. Greece not only has a high incidence of earnings management but is also required under the new European Commission (EC) regulation to comply with mandatory auditor rotation. Therefore, Greece is an ideal setting in which to study the association between auditor tenure and accounting conservatism.

Design/methodology/approach

Similar to Jenkins and Velury (2008), this paper uses Basu’s (1997) asymmetrical timeliness of earnings as a measure of conservatism. Following Li (2010), the regression is re-estimated for subsamples based on client importance as measured by the ranking of client sales among all clients audited by the firm.

Findings

In contrast to Li (2010), the results of this study, which used a sample of firms in Greece, indicate that conservatism decreases as the auditor–client relationship lengthens. Client importance does not appear to affect the relationship between auditor tenure and conservatism, as measured by asymmetric timeliness of earnings. However, when using the accrual–cash flow measure of conservatism (Ball and Shivakumar, 2005), it is found that auditor tenure is positively (negatively) associated with conservatism for less (more) important clients. The results suggest that longer auditor tenure may have a negative impact on audit quality in certain countries where accounting quality has been found to be poor. Therefore, the new EC regulation requiring mandatory auditor rotation may in fact improve audit quality for firms in Greece.

Research limitations/implications

This study’s sample consists of firms on the Athens Stock Exchange for the period of 1998-2011. This sample was purposely selected because of the unique conditions of rampant earnings management and low incentive in Greece for the auditors to exert effort to detect such practices. Moreover, Greece is subject to the new EC regulations requiring mandatory auditor rotation beginning in 2014. Future studies could examine this issue in alternate settings and over different time periods. Also, other cross-sectional variations among firms which affect the association between auditor–client tenure and audit quality may exist.

Practical implications

The findings are important to regulators such as the EC and indicate that Greece may be an appropriate setting in which to require mandatory auditor rotation. These results are also useful to auditors who wish to improve the audit quality and the public’s perception of their work.

Originality/value

Auditor tenure has been the subject of considerable debate, and regulators contend that long auditor tenure reduces audit quality. There may be a valid argument in favor of mandatory auditor rotation in countries particularly susceptible to low accounting quality due to issues such as rampant earnings management. Greece appears to be one such example, and this study provides support in favor of that argument by demonstrating that longer auditor tenure may lead to lower accounting quality in terms of conservatism. Therefore, the recent EC regulation may result in improved audit quality for firms in Greece.

Details

Managerial Auditing Journal, vol. 31 no. 6/7
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 24 July 2009

Ali R. Almutairi, Kimberly A. Dunn and Terrance Skantz

The purpose of this paper is to examine the relation between a company's bid‐ask spread, a proxy for information asymmetry, and auditor tenure and specialization.

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Abstract

Purpose

The purpose of this paper is to examine the relation between a company's bid‐ask spread, a proxy for information asymmetry, and auditor tenure and specialization.

Design/methodology/approach

The tests use clustered regression for a sample of 31,689 company‐years from 1992 to 2001 and control for factors known to impact bid‐ask spread in cross‐section.

Findings

The findings suggest that the market's perception of disclosure quality is higher and private information search opportunities are fewer for companies engaging industry specialist auditors. In addition, the paper finds that information asymmetry has a U‐shaped relation to auditor tenure. This U‐shaped relation holds for both specialists and non‐specialists; however, the bid‐ask spread for specialists tends to fall below that of non‐specialists at all tenure intervals.

Research limitations/implications

The findings may directly result from auditor tenure and specialization or it may be that those auditor‐related characteristics are a subset of concurrent choices made by the company that impacts disclosure quality.

Practical implications

Companies have incentives to lower information asymmetry and the findings document that the choice of a specialist auditor and the length of the auditor relationship can potentially influence this objective.

Originality/value

The paper provides information to academics, regulators, companies, and auditors concerning the effect of auditor‐client relationships on the level of information asymmetry. In addition, it shows the importance of industry specialization and audit firm tenure on audit quality.

Details

Managerial Auditing Journal, vol. 24 no. 7
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 16 August 2021

Khairul Anuar Kamarudin, Wan Adibah Wan Ismail and Akmalia M. Ariff

This study aims to investigate whether auditor tenure has a significant influence on accounting quality and whether investor protection moderates the effect of auditor…

Abstract

Purpose

This study aims to investigate whether auditor tenure has a significant influence on accounting quality and whether investor protection moderates the effect of auditor tenure on accounting quality.

Design/methodology/approach

This study uses weighted least squares regression on a sample of 77,855 firm-year observations from 36 countries during the period 2010–2016. This study uses the absolute value of performance-matched discretionary accruals to measure financial reporting quality.

Findings

This study finds that a longer auditor tenure is associated with higher accounting quality, thus supporting the knowledge effect arguments. The results on the joint effect of investor protection and auditor tenure show evidence of the substitutive effect of investor protection, where the positive impact of auditor tenure on accounting quality is weaker in a high investor-protection environment.

Practical implications

These findings provide input for policy implications involving the auditing profession. Regulators may need to weigh the costs and benefits of mandatory audit rotation because country-level institutional factors influence auditing regulations and practices, as well as the auditors’ behaviors.

Originality/value

This study adds to the limited, albeit important, evidence on the joint effect of auditor tenure and country-level governance on accounting quality. The authors respond to the call by Brooks et al. (2017) for more evidence on the role of audits on financial reporting outcomes across various legal institutions for creating effective policies.

Details

Accounting Research Journal, vol. 35 no. 2
Type: Research Article
ISSN: 1030-9616

Keywords

Article
Publication date: 18 May 2010

Li‐Chin Jennifer Ho, Chao‐Shin Liu and Thomas Schaefer

The purpose of this paper is to examine the relation between audit tenure and how clients manage the annual earnings surprise.

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Abstract

Purpose

The purpose of this paper is to examine the relation between audit tenure and how clients manage the annual earnings surprise.

Design/methodology/approach

A sample of 5,029 firm‐year observations from 1996 to 2003 were employed to examine whether audit tenure is negatively related to the incidence of accrual‐based‐upward earnings management to avoid negative earnings surprises; and whether audit tenure is positively related to the incidence of downward forecast guidance to avoid negative earnings surprises.

Findings

Empirical results indicate a substitution of downward forecast guidance for upward earnings management as audit tenure lengthens.

Research limitations/implications

The paper provides evidence that, as the auditor‐client relationship lengthens over time, firms turn to downward forecast guidance as a substitute for upward earnings management. One possible limitation of the sample period involves the implementation of the Sarbanes‐Oxley Act (SOX) of 2002. Because of the increased financial reporting scrutiny on both management and auditors that accompanies SOX, it is likely that constraints on earnings misstatements increase after SOX. Any decrease in upward earnings management resulting from SOX would thus work against finding a relation between audit tenure and the substitution of downward forecast guidance to prevent negative earnings surprises.

Originality/value

This paper supports the notion that audit tenure affects firms' choices among various tactics in their attempts to avoid negative earnings surprises. The results also contribute to the ongoing debate on mandatory audit firm rotation by showing that audit quality increases with audit tenure.

Details

Review of Accounting and Finance, vol. 9 no. 2
Type: Research Article
ISSN: 1475-7702

Keywords

1 – 10 of over 3000