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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: 12 February 2018

Mark Kohlbeck, Jomo Sankara and Errol G. Stewart

This paper aims to examine whether external monitors (auditors and analysts) constrain earnings strings, an indicator of earnings management, and whether this monitoring…

Abstract

Purpose

This paper aims to examine whether external monitors (auditors and analysts) constrain earnings strings, an indicator of earnings management, and whether this monitoring is more effective after the implementation of the Sarbanes-Oxley Act of 2002 (SOX), given the emphasis of SOX on improving auditing, financial reporting and the information environment.

Design/methodology/approach

Agency theory establishes the premise between external monitoring and earnings strings. Auditor tenure and number of analysts following provide measures for external monitoring quality. Using prior research, empirical models explaining the presence of an earnings strings and earnings strings trend are developed to test the hypotheses.

Findings

Pre-SOX, extreme auditor tenure, indicating lower quality external monitoring, is associated with greater earnings strings trend, and analyst coverage is associated with increased likelihood of earnings strings and greater earnings strings trend consistent with analyst pressure on management. More effective auditor and analyst monitoring occurs post-SOX in terms of reduced likelihood of earnings strings and earnings strings trend.

Originality/value

The authors provide evidence on how elements of external monitoring are associated with increased earnings strings pre-SOX. Further, they contribute to the debate on the impact of SOX on external firm monitoring and the overall financial information environment. By focusing on earnings strings, the outcome of earnings management, the authors provide a unique understanding of external monitoring that also provides insight on the overvaluation of equity and ultimate destruction of firm value. The evidence demonstrates how regulation has contributed to an improved financial reporting environment and external monitoring.

Details

Review of Accounting and Finance, vol. 17 no. 1
Type: Research Article
ISSN: 1475-7702

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: 2 March 2015

Lynn Johnson and Terrence B. O'Keefe

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…

1031

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.

Details

Managerial Auditing Journal, vol. 30 no. 3
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 28 October 2001

David H. Sinason, Jefferson P. Jones and Sandra Waller Shelton

The purpose of this study is to examine the duration of the auditor’s relationship with a client and factors that affect audit firm tenure. The duration of the auditor and…

642

Abstract

The purpose of this study is to examine the duration of the auditor’s relationship with a client and factors that affect audit firm tenure. The duration of the auditor and client relationship has been cited as possibly affecting the risk of a loss of auditor independence. Also, audit firm tenure has been used as an independent variable in several studies with variations on the characterization of a “long auditor‐client association.” However, little is known about the duration of the auditor’s relationship with a client. Generally, no empirical justification is provided for the treatment of the variable and no consideration is included for auditor or client factors that may affect the relationship. This study evaluates the duration of the auditor relationship with a client and determines which factors contribute to changes in that relationship. In an examination of 16,976 COMPUSTAT companies over a twentyyear period, the mean duration of audit tenure is found to be more than six years. However, audit tenure is affected by client size, client growth rate, and type of audit firm involved in the change of auditor. Audit tenure is not affected by audit firm size, client risk, or audit opinion.

Details

American Journal of Business, vol. 16 no. 2
Type: Research Article
ISSN: 1935-5181

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: 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: 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: 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: 27 July 2020

Nancy Chun Feng

Using a sample of US nonprofit organizations, where the identity of the auditor in charge of the audit is revealed, I investigate whether individual auditor

Abstract

Purpose

Using a sample of US nonprofit organizations, where the identity of the auditor in charge of the audit is revealed, I investigate whether individual auditor characteristics (gender, engagement size and tenure) are associated with audit quality.

Design/methodology/approach

To investigate how individual audit partner characteristics affect audit quality, I follow Petrovits et al. (2011) and Fitzgerald et al. (2018) who investigate client characteristics and partner tenure as determinants of ICDs in nonprofits. I add three characteristics of the auditor in charge – gender, engagement size and tenure – to their models. In additional analyses, I use subsamples partitioned by client risk and audit firm size, and find that individual auditor characteristics generally play a more significant role in the issuance of ICDs and QAOs for riskier clients than for less risky clients.

Findings

My results show that female auditors are more likely to report internal control deficiencies and issue qualified audit opinions (QAOs) to nonprofits. I also find that auditors with more Single Audit engagements within the same year are less likely to report ICDs. In addition, auditor tenure is negatively associated with the likelihood of issuing an ICD report, suggesting that auditors become complacent as the length of the auditor–client relationship lengthens or, alternatively, that they are better able to assist their clients in correcting ICDs and in maintaining stronger internal control environments as they gain client-specific knowledge over time. Additional analysis suggests tenure and engagement load results are sensitive to the sample specification employed.

Research limitations/implications

One caveat of this study is that self-selection bias may be present when a client chooses an audit firm, the audit firm selects a client, and the audit firm assigns a partner to the engagement. Future study with more advanced econometric models is needed to mitigate self-selection bias. Another limitation is that my sample consists of nonprofit organizations and may not be generalizable to for-profit firms. Another caveat of this study is that the tenure variable is truncated compared to prior literature (e.g. Fitzgerald et al., 2018). Also given the rarity of audit quality measures in the nonprofit setting, internal control deficiencies and qualified opinions are used as proxies for audit quality because they reflect both the quality of audit work and the quality of organizations' internal control and financial reporting. Future studies with data including additional audit quality measures could shed more light on the topic.

Originality/value

This study contributes to the literature in several ways. First, this study offers a more comprehensive examination on the impact that a broader set of individual auditor characteristics on audit quality in the nonprofit setting, compared to Fitzgerald et al.'s (2018) study. Second, the findings should be of interest to policymakers who recently mandated engagement partner disclosures from US audit firms (PCAOB, 2015b). Finally, another distinctive feature of this study is that I examine the impact of individual auditor characteristics on audit quality in a setting where Big 4 audit firms are not dominant.

Details

Journal of Public Budgeting, Accounting & Financial Management, vol. 32 no. 4
Type: Research Article
ISSN: 1096-3367

Keywords

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