Audit Firm Tenure, Bank Complexity, and Financial Reporting Quality

51 Pages Posted: 18 Apr 2015 Last revised: 21 Dec 2017

See all articles by Brian Bratten

Brian Bratten

University of Kentucky - Von Allmen School of Accountancy

Monika Causholli

University of Kentucky - Von Allmen School of Accountancy

Thomas C. Omer

University of Nebraska at Lincoln - School of Accountancy

Date Written: November 2017

Abstract

Theory from organizations and economics research posits that in an inter-organizational relationship, both parties invest in relationship-specific knowledge, which in turn facilitates the effectiveness of the relationship while strengthening the attachment between the parties. In complex settings where there are more opportunities for knowledge creation, the investments will be larger and the attachment stronger. Because banks are complex institutions that present unique challenges to auditors, we suggest that effective audits critically depend on the accumulation of significant investments in client-specific expertise through a long association with the client. We find a positive association between audit firm tenure and financial reporting quality, and this association is particularly strong in banks that are more complex. Also, contrary to recent research we find that benefits of audit firm tenure for complex banks accrue even for long tenure and are not limited to medium tenure. Our findings largely support the notion that a long relationship with the client reflects the underlying demand for expertise, which is critical for high-quality audits of complex organizations. Imposing short-term limits on audit firms would adversely affect the investments in client-specific expertise especially in the cases where this expertise is needed the most. Our findings do not support calls for mandatory audit firm rotation for large complex institutions.

Keywords: audit tenure, banking, mandatory rotation, complexity

JEL Classification: M41, M42, G18, G21

Suggested Citation

Bratten, Brian and Causholli, Monika and Omer, Thomas C., Audit Firm Tenure, Bank Complexity, and Financial Reporting Quality (November 2017). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2595592 or http://dx.doi.org/10.2139/ssrn.2595592

Brian Bratten

University of Kentucky - Von Allmen School of Accountancy ( email )

Lexington, KY 40506
United States

Monika Causholli

University of Kentucky - Von Allmen School of Accountancy ( email )

Lexington, KY 40506
United States

Thomas C. Omer (Contact Author)

University of Nebraska at Lincoln - School of Accountancy ( email )

307 College of Business Administration
Lincoln, NE 68588-0488
United States

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