Exploring the Term of the Auditor-Client Relationship and the Quality of Earnings: A Case for Mandatory Auditor Rotation?

Abstract:     
In this study, we document evidence on the relation between auditor tenure and earnings quality using the dispersion and sign of both absolute Jones-model abnormal accruals and absolute current accruals as proxies for earnings quality. Our study is motivated by calls for "mandatory auditor rotation" which are based on concerns that longer auditor tenure reduces earnings quality. Multivariate results, controlling for firm age, size, industry growth, cash flows, auditor type (Big 8 vs. non-Big 8), industry, and year, generally suggest higher earnings quality with longer auditor tenure. We interpret our results as suggesting that, in the current environment, longer auditor tenure on average results in auditors placing greater constraints on extreme management decisions in the reporting of financial performance.

Keywords: auditor tenure, earnings quality, audit quality, mandatory rotation

JEL Classification: M41, M49

Accepted Paper Series