45 Pages Posted: 26 Sep 2011
Date Written: September 25, 2011
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: 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