Auditor Tenure and the Ability to Meet or Beat Earnings Forecasts

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