Does Long Tenure Erode Auditor Independence?

Abstract

Regulators have shown a renewed interest in considering the merits of mandatory auditor rotation. A fundamental concern is that long tenure may undermine auditor independence. We conduct a study to investigate the effects of long tenure on companies’ allowance for bad debts (ABD). We focus on ABD, as opposed to total accruals, because it allows us to hone in on the effect of auditor tenure on a specific accrual. By examining ABD, we are able to conduct a more direct and powerful test and avoid some of the measurement error and noise associated with total accruals (e.g., discretionary or abnormal). We find evidence of a negative association between auditor tenure and estimated ABD. The finding holds across a series of robustness tests. Further analyses suggest that long tenure (around 15 years) is associated with downward bias in estimated ABD. With long tenure, the auditor endorses an estimate of ABD that is too aggressive. This result is consistent with the argument that long tenure leads to compromised independence. Our findings suggest that a term limit of 10 years, which has been suggested elsewhere (e.g., PCAOB 2010; Chasan 2011), is sufficient to preserve auditor independence.

Keywords: auditor tenure, auditor independence, accounting reporting

JEL Classification: M41