These findings should be of interest to policy makers in China because, among other implications, the results suggest that Chinese regulators should pay attention to the switching of audit partners before they reach tenure limit for mandatory rotation. Partner-level opinion shopping could be more difficult to detect in markets in which the identity of the engagement partner is not disclosed, and it may therefore be prevalent in those markets, such as the United States.

 Chen, F., A. Peng, S. Xue, Z. Yang, and F. Ye. 2016. Do Audit Clients Successfully Engage in Opinion Shopping? Partner-Level Evidence. Journal of Accounting Research 54 (1): 79-112.

Opinion shopping refers to the practice by which audit clients seek alternative auditors willing to give a clean audit opinion when the incumbent auditor is likely to issue an unclean opinion. Existing studies examine whether companies successfully engage in opinion shopping through switching audit firms using data from such countries as China, the United Kingdom, and the United States. In this study, the authors examine evidence of switching audit partners within the same firm rather than switching to another firm for clean audit opinions, which they term “partner-level opinion shopping.” Statements from the PCAOB suggest that partner-level rotation shopping has become a regulatory concern and the regulators believe that this practice may be more prevalent if the names of engagement partners are not publicly disclosed; however, there is no empirical evidence on the existence and extent of partner-level opinion shopping to the best of the authors’ knowledge. Consequently, the authors attempt to fill this gap in the auditing literature by testing whether companies successfully engage in partner-level opinion shopping.

The authors decided to use data from China because engagement partners in China are required to sign the audit report, which enables the authors to identify partner switches before partners reach their mandatory rotation limit. The sample consists of observations from 1998 to 2012. They use an audit reporting model to determine a company’s probability of receiving a modified audit opinion (MAO) with and without a partner switch. 

• The authors find consistent results for partner-level opinion shopping for both field partner and review partner switching.
• The authors’ findings support the notion that partner-level opinion shopping is less likely to be successful for companies audited by firms organized as partnerships.
• The authors find no evidence suggesting that outgoing audit partners are overly conservative compared with an average audit partner with an expected conservatism score of zero; the authors do not find evidence that incoming partners are less conservative than outgoing partners.
• The authors find evidence that Chinese companies successfully engage in partner-level opinion shopping.
• The authors find that the extent of success in opinion shopping is affected by client importance and the organizational forms of audit firms.
• The authors’ results show that companies that successfully engage in opinion shopping report significantly lower-quality earnings, as indicated by higher discretionary accruals and a higher likelihood of reporting small profits.
• The authors find direct evidence that incoming audit partners, for companies that obtain more favorable audit opinions after a partner switch, have a higher propensity to issue clean opinions than outgoing partners.

www.auditingresearchsummaries.org

This study provides the first evidence using U.S. data on the relationships between audit planning and pricing and audit partner tenure. Importantly, the results speak to the requirement in SOX Section 203 that audit partners on public clients rotate every five years. The second set of results concerns changes in auditor risk responsiveness during the period 2002 to 2003. Because there are very few longitudinal studies of engagement effort that feature a consistent sample of clients over time, this study contributes to understanding of changes in audit firms’ risk responsiveness.

Bedard, J. C., and K. M. Johnstone. 2010. Audit Partner Tenure and Audit Planning and Pricing. Auditing: A Journal of Practice & Theory 29 (2): 45-70.

This paper investigates the association between audit engagement partner tenure and audit planning and pricing. Limitations on partner tenure for public company engagements exist in many developed countries. For instance, in the U.S., the AICPA’s SEC Practice Section has long had a professional requirement that audit partners of public clients be rotated at least once every seven years. Section 203 of the Sarbanes-Oxley Act (SOX) codifies a partner tenure limitation for public companies into law, and reduces the period to five years. Proponents of frequent partner rotation argue that the auditor’s independence and objectivity suffer from long tenure with the client, which may result in lower audit quality, and that the fresh perspective of a new partner is thereby beneficial. However, many in the auditing profession maintain that mandatory partner rotation causes unnecessary costs, and may in fact impair audit quality. This position is derived from concerns that while client information is stored in the workpapers, each new engagement partner faces a certain amount of information asymmetry due to less history of client interaction.

The data includes client characteristics and plans for audit engagements of publicly traded companies to be conducted during 2002 and 2003, gathered by the participating audit firm in support of its client continuance decisions. The final sample size is well over 500. The models consider 2002–2003 risk assessments and audit planning/pricing decisions for the firm’s continuing public clients in 2002, i.e., those that the firm audited in 2001 and prior years.

• The level of planned effort does not differ for clients having longer versus shorter tenure partners.
• Engagements with longer partner tenure have significantly higher realization rates, suggesting that client demand for services of those partners and associated reduction in fee pressure enables a greater return on their engagements.
• Results reveal that relative to the prior year engagement of the client, audit effort increases in the year of the partner change.
• Planned realization rates decline in the year of the partner rotation.
• In combination, the results suggest that tightening the term of mandatory partner rotation from seven to five years removes a service valued by clients.
• Levels of risks related to financial reporting quality, management integrity, and internal controls are positively associated with the levels of planned effort in 2002.
• Changes in assessments of financial reporting risk, management integrity risk and internal control risk are positively associated with changes in planned effort from 2002 to 2003.
• Overall, the authors conclude that from 2002–2003, the firm’s risk response was strong in 2002, and further increased in 2003. This change was more predominant in effort rather than unit pricing, which has positive implications for audit quality.

http://www.auditingresearchsummaries.org

The results of this study are limited to the debate concerning individual audit partner rotation and do not support the argument for, or negate the prior studies that examine, audit firm rotation.  Combining the results of this study with the prior studies suggests that audit firms develop, over time, client and industry-specific knowledge that increases their ability to provide quality audits, and if quality control procedures within the firm are adequate (such as might be expected at a Big 6 firm), then rotating audit partners periodically helps maintain the auditor’s independence and objectivity while minimizing the loss of client-specific knowledge and rtise.

Carey, P. and R. Simnett 2006. Audit Partner Tenure and Audit Quality. The Accounting Review 81 (3): 653-676.

For many years, regulators have expressed concern regarding auditors’ extended associations with particular audit clients (i.e., long auditor tenure) and its potential impact on auditors’ independence and objectivity.  In the U.S., the AICPA Practice Section mandated in the 1970’s that audit partners rotate off their client after a seven year period.  The Sarbanes-Oxley Act of 2002 decreased this period to five years for public company engagements.  Outside the U.S., countries following international accounting standards and the Code of Ethics implemented by the International Federation of Accountants, as well as the United Kingdom and Australia, adopted similar standards by the early 2000’s due to the perceived “familiarity threat” associated with long auditor tenure.  Two of the arguments for mandatory rotation are that long auditor tenure 1) results in personal relationships with the client that could impair, consciously or subconsciously, the auditor’s independence, and 2) weakens the auditor’s ability to critically evaluate the client’s assertions.  However, to date, there is little empirical evidence to support these
arguments.

Due to data limitations, previous studies examining auditor tenure tend to focus on tenure of the audit firm as a whole.  Contrary to regulators’ perceptions, those studies tend to find that audit quality actually deteriorates in the early years after a change in the client’s audit firm, which is attributed to the “learning curve” effect, and that higher audit quality is associated with longer audit firm tenure, which is consistent with the audit firm developing more knowledge and familiarity with the client and industry as time progresses.  Based on their actions, regulators appear convinced that the potential benefits associated with auditor rotation are greater than the potential risks.  Therefore, the purpose of this study is to further examine whether long auditor tenure contributes to decreased audit quality in a setting where individual audit partners can be identified for particular audit clients.

The authors rely on data for Australian-domiciled companies publicly traded on the Australian Stock Exchange in 1995.  The authors accumulate auditor tenure information through 1997.

The authors proxy for audit quality using three different measures: 1) the auditor’s propensity to issue a going-concern opinion; 2) the client’s reporting of abnormal working capital accruals; and 3) the extent to which key earnings targets are just beaten or missed.  Using the results of prior studies and the arguments and policies provided by regulators, the authors examine the association between audit quality and three measures of auditor tenure: less than two years, three to seven years, and greater than seven years.

• For going-concern opinions, the authors find that longer audit partner tenures do decrease the individual auditors’ propensity to issue such an opinion.  Sensitivity analyses for this test suggest that these results are driven by non-Big 6 audit firm partners.
• The results of this study find no association between abnormal working capital accruals and longer audit partner tenure. 
  These findings are in contrast to a prior study that examines the Taiwanese market and does find some support for an increased association between abnormal accruals (i.e., lower earnings quality) and longer auditor tenures,
• The results show limited evidence of fewer clients just missing earnings benchmarks (i.e., more clients beating earnings benchmarks) in cases where the audit partner has longer tenure at the client.