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Auditor Tenure and the Ability to Meet or Beat Earnings Forecasts

52 Pages Posted: 17 Sep 2007 Last revised: 29 Oct 2008

Larry R. Davis

Michigan Technological University - School of Business and Economics

Billy S. Soo

Boston College

Gregory M. Trompeter

Boston College

Date Written: August 28, 2007

Abstract

We examine the relation between auditor tenure and a firm's ability to use discretionary accruals to meet or beat analysts' earnings forecasts. Regulators have long expressed concern over the use of earnings management to attain earnings targets. These concerns are compounded by lingering questions over whether long-term auditor-client relationships impair an auditor's ability to independently stem such practices. The profession counter-argues that mandatory auditor rotation reduces auditors' familiarity with the client and adversely affects audit quality. Consistent with both arguments, we find that firms with both short (two to three years) and long (13-15 years or more) tenure are more likely to report levels of discretionary accruals that allow them to meet or beat earnings forecasts. The results suggest that while regulatory mandates for periodic auditor turnover have negative effects, sustained long term auditor-client relationships may be also detrimental to audit quality. The generalizability of our results may not extend to firms that are not covered by analysts, as these firms do not face the same public pressure to manage earnings in order to meet or beat expectations.

Keywords: auditor tenure, analysts forecasts, earnings management, discretionary accruals

JEL Classification: M49, M41, M43, G29

Suggested Citation

Davis, Larry R. and Soo, Billy S. and Trompeter, Gregory M., Auditor Tenure and the Ability to Meet or Beat Earnings Forecasts (August 28, 2007). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1014601 or http://dx.doi.org/10.2139/ssrn.1014601

Larry R. Davis

Michigan Technological University - School of Business and Economics ( email )

Houghton, MI 49931
United States

Billy S. Soo (Contact Author)

Boston College ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617-552-3963 (Phone)
617-552-2097 (Fax)

Gregory M. Trompeter

Boston College ( email )

Carroll School of Management 140 Commonwealth Avenue
Chestnut Hill, MA 02167
United States
617-552-0878 (Phone)
617-552-2097 (Fax)

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