On the Economics of Mandatory Audit Partner Rotation and Tenure: Evidence from PCAOB Data

61 Pages Posted: 23 Aug 2017 Last revised: 24 Mar 2020

See all articles by Brandon Gipper

Brandon Gipper

Stanford University Graduate School of Business

Luzi Hail

University of Pennsylvania - The Wharton School

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network

Multiple version iconThere are 3 versions of this paper

Date Written: March 17, 2020

Abstract

We provide the first partner tenure and mandatory rotation analysis for a large cross-section of U.S. publicly listed firms over an extended period. We analyze the effects on audit quality as well as on audit pricing and production. On average, we find no evidence for audit quality declines over the tenure cycle and, consistent with this result, little support for fresh-look benefits after five-year mandatory rotations. Nevertheless, partner rotations have significant economic consequences. Audit fees decline and audit hours increase after mandatory rotations, but then reverse over the tenure cycle. We also find evidence that audit firms use “shadowing” in preparation of lead partner turnover. The economic effects differ predictably by competitiveness of the local audit market, client size, and partner experience. When multiple members of the audit team start together at a new client, the transition appears to be more disruptive (but still less so than switching the audit firm) and more likely to exhibit audit quality effects, such as fresh look. Overall, our findings are consistent with costly efforts by the audit firms to minimize both disruptions and audit failures around mandatory rotations.

Keywords: Auditing, Audit fees, Audit quality, Auditor rotation, Audit partner tenure, Competition, PCAOB

JEL Classification: J01, J44, L84, M21, M42

Suggested Citation

Gipper, Brandon and Hail, Luzi and Leuz, Christian, On the Economics of Mandatory Audit Partner Rotation and Tenure: Evidence from PCAOB Data (March 17, 2020). Stanford University Graduate School of Business Research Paper No. 17-56. Available at SSRN: https://ssrn.com/abstract=3023725 or http://dx.doi.org/10.2139/ssrn.3023725

Brandon Gipper (Contact Author)

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