The results of this study are important for regulators to consider when scrutinizing auditor changes and former audit partners. The evidence indicates that former audit partners may adopt a strategic approach to auditing follower clients by being more conservative in their audits in the first post-switch year when the level of scrutiny is high, but allowing more aggressive earnings management after the first post-switch year.

Chen, C. J. P., X. Su, and X. Wu. 2009. Forced Audit Firm Change, Continued Partner-Client Relationship, and Financial Reporting Quality.  Auditing: A Journal of Practice and Theory 28 (2): 227-246. 

The authors use a setting of forced auditor changes (e.g. the forced demise of Andersen resulting in partners and staff going to work for other firms) to examine whether clients follow their former audit partner, and the implications for earnings management.  Forced auditor changes following an audit failure scandal raise the level of perceived and/or actual regulatory risk to both former audit partners and the new audit firms that take on such partners. However, regulatory scrutiny of the new audit firm in subsequent years may not be as strong as in the first year following the partner switch to the new audit firm. This study investigates the financial reporting quality of Chinese listed firms following forced partner/audit firm changes. The main objectives of the study are to  determine whether: 

• Former audit partners tend to be more conservative in the first post-switch year.
• Former audit partners become less conservative after the first post-switch year.

The authors use data on publicly-traded companies in the Chinese stock market which faced forced partner/audit firm changes in 2001 to examine the financial reporting quality associated with audits performed by these audit partners with their new audit firm in the post-switch years.

• The authors document that firms with greater earnings management activities are more likely to follow their former audit partners to a new audit firm.  
• Follower clients with aggressive earnings management behavior who are audited by former partners do not report abnormally high earnings management in the first post-switch year. 
• While new audit firms are more likely to assign brand new audit partners to follower clients in the first post-switch year, a large number of former audit partners return to their clients in subsequent years. 
• The authors find that the financial reporting of aggressive follower clients audited by former partners becomes significantly more aggressive in the second and third post-switch years.

The results from this study are important for regulators when considering mandatory audit firm rotation. The evidence suggests that auditors are concerned about the length of their new client’s relationship with their former auditor and perceive this as a risk factor in pricing their engagements. 

However, the authors caution that the evidence does not necessarily support mandatory rotation. As Andersen was a high-profile case, it is possible that the fee premium observed in this study is unique to Andersen clients. Moreover, in examining mandatory rotation, the authors suggest that switching costs should also be considered in conjunction with the fee premium.

Kealey, B. T., H. Y. Lee, and M. T. Stein. 2007. The Association between Audit-Firm Tenure and Audit Fees Paid to Successor Auditors: Evidence from Arthur Andersen.  Auditing: A Journal of Practice and Theory 26 (2): 95-116.

There has been a long-standing debate on the effect of auditor tenure on audit quality and whether mandatory auditor rotation should be imposed on audit firms. Opponents of mandatory rotation, including the accounting industry, have argued that longer auditor tenure leads to more institutional knowledge being possessed by the auditor about their clients. This in turn helps increase audit effectiveness and audit quality. Proponents of mandatory rotation contend that it will lead to increases in actual and perceived independence and audit quality. 

Recently, the Sarbanes-Oxley Act of 2002 set the mandatory tenure limits on engagement and review partners. While Congress was also interested in limiting audit firm tenure, they have not imposed such a requirement, but instead have issued a request for additional research on the impact of auditor tenure on independence. This study addresses Congress’ concern on the effect of tenure on auditor independence by examining whether successor auditors view their clients’ tenure with the predecessor auditor as a risk factor and whether they price this perceived lack of independence.

The authors use data on publicly-traded companies which were audited by Arthur Andersen in 2001, but who switched to another auditor in 2002. They examine the association between client tenure with Andersen and audit fees charged by the successor auditor.

The authors document that newly hired auditors charge higher audit fees when the length of the client’s tenure with Arthur Andersen was higher. This suggests that new auditors perceive increased tenure with a predecessor auditor as riskier.