Audit Firm Tenure and Audit Quality: Evidence from U.S. Firms

Abstract

We propose that audit quality is likely to increase in the earlier years due to a Learning Effect and in later years it decreases due to a Bonding Effect. Adopting a quadratic model, we find that the average turning point is between 12 to 16 years for a large sample of U.S. firms. With an average tenure of 9 years in our sample, these findings imply that mandatory auditor firm rotation may not be necessary. Further, we find that the turning point varies by auditor - it is longer for non-Big N auditors, non-specialist auditors, and auditors with high client importance, and the deterioration of audit quality exists in low litigation industries only, consistent with the Bonding Effect explanation. Moreover, we find the turning point gets longer in the post-SOX period. Our results have implications for the current debate on mandatory audit firm rotation.

Keywords: audit firm tenure, mandatory auditor rotation, audit quality, independence, turning point

JEL Classification: M41, G31