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When Does Audit Quality Start to Decline in Firm Audit Tenure? - An International Analysis

45 Pages Posted: 26 Sep 2011  

Li Zheng Brooks

Washington State University - Department of Accounting

C.S. Agnes Cheng

Hong Kong Polytechnic University - School of Accounting and Finance

Joe Johnston

Illinois State University - Department of Accounting

Kenneth John Reichelt

Louisiana State University, Baton Rouge - Department of Accounting

Date Written: September 25, 2011

Abstract

This paper investigates the decline in audit quality during an audit firm’s tenure across countries with varying degrees of legal liability. We propose that audit quality can increase through a learning effect in early years but in later years it is likely to decrease due to a bonding effect. Using a quadratic model, we estimate the year when audit quality, measured by earnings quality, starts to decline during an audit firm’s tenure. We propose that the bonding effect should be weaker in countries with stricter legal liability regimes, which implies that the year that audit quality begins to decline should be later in countries with stricter legal liability regimes. We find that it takes 14 to 16 years for countries with stronger legal liability regimes while it only takes 4 to 10 years for countries with weaker legal liability regimes for audit quality to decline. Our results are strong regardless of whether we measure legal liability from the perspective of legal origin (common or code law) or litigation risk. Our findings have implications across the world for the current debate on the mandatory requirement of audit firm rotation across the world.

Suggested Citation

Brooks, Li Zheng and Cheng, C.S. Agnes and Johnston, Joe and Reichelt, Kenneth John, When Does Audit Quality Start to Decline in Firm Audit Tenure? - An International Analysis (September 25, 2011). Available at SSRN: https://ssrn.com/abstract=1933488 or http://dx.doi.org/10.2139/ssrn.1933488

Li Zheng Brooks

Washington State University - Department of Accounting ( email )

Pullman, WA 99164
United States
509-595-0124 (Phone)

C.S. Agnes Cheng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon, Kowloon
Hong Kong

Joseph Atkins Johnston

Illinois State University - Department of Accounting ( email )

United States
309-438-3830 (Phone)

Kenneth John Reichelt (Contact Author)

Louisiana State University, Baton Rouge - Department of Accounting ( email )

2821 Business Education Complex
Baton Rouge, LA 70803
United States
225-578-6233 (Phone)

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