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  • The Auditing Section
    Audit Partner Tenure and Audit Quality
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Audit Partner Tenure and Audit Quality
    Practical Implications:

    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.

    Citation:

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

    Keywords:
    audit partner tenure; audit quality; qualifications; earnings management
    Purpose of the Study:

    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.

    Design/Method/ Approach:

    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.

    Findings:
    • 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.
    Category:
    Independence & Ethics, Audit Team Composition, International Matters
    Sub-category:
    Audit Firm Rotation, Partner Rotation, Audit Partner Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    Audit Partner Tenure and Cost of Equity Capital
    research summary posted May 28, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    Audit Partner Tenure and Cost of Equity Capital
    Practical Implications:

    Prior research suggests that the length of auditor-client relationship affects audit quality, and, therefore, the integrity and information risk associated with a clients’ financial reporting. This study attempts to examine the effects of audit engagement partner tenure and rotation on investors’ perceptions. The results of this study raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner’s identity or pay attention to audit partner tenure. If investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure.  

    Citation:

    Azizkhani, M., G. S. Monroe, and G. Shailer. 2013. Audit Partner Tenure and Cost of Equity Capital. Auditing 32 (1).

    Keywords:
    audit partner rotation; audit partner tenure; cost of capital; financial reporting credibility
    Purpose of the Study:

    Recent proposals by the PCAOB suggest that audit firms should be required to identify the name of the engagement partner in the audit report. The proposals suggest that this provides useful information to investors by allowing investors to identify audit partner tenure and rotation. Professional accounting bodies and regulators have long been concerned that long auditor-client relationships impair audit quality. The PCAOB, however, has noted that other commenters do not believe disclosure of partner identity will provide meaningful information to investors. This study investigates the usefulness of disclosing partner identity by exploring whether audit partner tenure and partner rotation are informative to investors, as indicated by the ex ante cost of equity capital.

    Design/Method/ Approach:

    The authors tested the relationship between client-specific ex ante cost of equity capital and audit partner tenure using two models. The client-specific ex ante cost of equity capital was estimated using the price-earnings ratio divided by the short-term earnings growth rate. Auditor tenure was tested using raw, long transform, and quadratic terms. The authors also used two-stage regressions to address the potential for Big 4 selection bias. The sample was selected for all Australian-domiciled companies listed on the Australian Stock Exchange during the 1995-2005 time period. 

    Findings:
    • Partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements.
    • Imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor.
    • Partner rotation is associated with increased ex ante cost of equity capital.  
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Changes in Audit Standards, Partner Rotation
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  • Jennifer M Mueller-Phillips
    Audit Report Lags after Voluntary and Involuntary Auditor...
    research summary posted June 22, 2013 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    Audit Report Lags after Voluntary and Involuntary Auditor Changes
    Practical Implications:

    Regulators have long debated mandating auditor rotation. This study quantifies some of the costs of auditor rotation, specifically its impact on audit report lag. The findings lend support to opponents of mandatory rotation, since the first year after rotation requires more audit effort. The study also highlights one benefit that partner-firm familiarity can have (in decreasing audit report lag).

    Citation:

    Tanyi P., K. Raghunandan, and A. Barua. 2010. Audit Report Lags after Voluntary and Involuntary Auditor Changes. Accounting Horizons 24 (4): 671-688.

    Keywords:
    Auditor tenure; auditor rotation; audit partner rotation
    Purpose of the Study:

    Because of recent debate about the costs of auditor rotation, the authors examine how mandatory and voluntary auditor rotation affects audit report lag, or the number of days between the fiscal year end and the audit report date.Prior research examines only voluntary auditor rotation, which might have different effects than the mandatory rotation advocated by regulators.

    Design/Method/ Approach:

    Authors use the demise of Arthur Andersen and firms’ subsequent auditor changes as a setting in which to learn about mandatory auditor rotation.

    Authors compare audit report lags for firms with fiscal yearend of December 31, 2002. Audit report lag is the only publicly observable, quantifiable measure of auditor effort.

    Andersen firms switch from Andersen to another audit firm in fiscal 2002, and control firms (voluntary rotation) switch from a Big5 audit firm in fiscal 2002.

    Authors also examine audit report lags in fiscal 2000.

    Authors also partition Andersen firms into firms that follow their Andersen partner into a new audit firm and those that do not.

    Findings:

    Andersen firms that do not follow their partners into a new audit firm have longer audit report lags than clients of other Big 5 auditors who switched to a new auditor in 2002. The audit report lag increases by 6.5 days (from 58.02 days to 62.57 days).

    Andersen firms that follow their audit partners into a new audit firm have shorter audit report lags (by 4.56 days or 7.8 percent) than Andersen firms that did not follow their audit partners.

    Compared with firms that do not change audit clients, firms with voluntary auditor changes experience only marginally longer audit report lags. Firms with mandatory auditor changes have significantly longer audit report lags.

     

    For more information on this study, please contact K. Raghunandan.

    Category:
    Independence & Ethics, Audit Team Composition
    Sub-category:
    Audit Partner Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    Benefits and Costs of Appointing Joint Audit Engagement...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Benefits and Costs of Appointing Joint Audit Engagement Partners
    Practical Implications:

     The results of this study are important to understanding the potential benefits of joint engagement partner audits compared to single-partner audits. The results of this study identify an association between the type of partner audit (joint vs. single) and audit quality and audit fees. As regulators consider the association between joint audits and audit quality, the results of this study suggest there are benefits to joint-partner audits, particularly when the partners are located in the same office. Compared to single-partner audits, joint-partner audits are associated with higher audit quality. Compared to joint audit firms, joint-partner audits appear to provide the same benefits without the increased cost.

    Citation:

    Ittonen, K., and P. C. Trønnes. 2015. Benefits and costs of appointing joint audit engagement partners. Auditing: A Journal of Practice & Theory 34 (3): 23-46.

    Keywords:
    Joint auditing; engagement partners; audit quality; audit fees
    Purpose of the Study:

    Audits using joint engagement partners versus audits using a single engagement partner may produce significant benefits. The purpose of this study is to examine the relationship between joint engagement partners and audit quality and audit fees. The authors of the study predict that joint audit partners improves audit quality via benefits in knowledge and experience, consultation availability with a joint partner, and reducing client-specific knowledge lost due to partner rotation.

    Design/Method/ Approach:

    The authors use 1,345 firm-year observations from the NASDAQ OMX Exchanges in Finland and Sweden for the period 2005 to 2009.

    Findings:
    • The authors find a stronger association between joint engagement partners and higher audit quality when the partners are from the same, rather than a different, office.
    • The authors find that joint engagement partners, compared to single partners, are associated with less accruals (two proxies for audit quality).
    • The authors find a small decrease in audit fees for joint engagement partners from different offices compared to single-partner audits. The authors find no difference in audit quality. 
    Category:
    Audit Team Composition, Independence & Ethics, International Matters
    Sub-category:
    Audit Firm Rotation, Audit Partner Rotation, Partner Rotation
  • Jennifer M Mueller-Phillips
    Costs of Mandatory Periodic Audit Partner Rotation: Evidence...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    Costs of Mandatory Periodic Audit Partner Rotation: Evidence from Audit Fees and Audit Timeliness
    Practical Implications:

    These findings provide valuable insight on the implications of mandatory periodic audit partner rotation in the U.S. First, partner rotation has an adverse effect as it increases both audit fees and audit timeliness. Second, the incremental costs of partner rotation are felt more by non-Big 4 city industry non-specialist auditors and their clients. Third, the results suggest these audit fees and audit report lag implications are similar for the second and third incoming audit partners following rotation. 

    Citation:

    Sharma, D. S., P. N. Tanyi, and B. A. Litt. 2017. Costs of Mandatory Periodic Audit Partner Rotation: Evidence from Audit Fees and Audit Timeliness. Auditing: A Journal of Practice and Theory 36 (1): 129 – 149. 

    Keywords:
    partner rotation, partner change, audit fees, audit report lag, audit firm rotation, audit delay, and industry specialist.
    Purpose of the Study:

     The authors examine how mandatory periodic audit partner rotation in the U.S. is related to audit fees and audit timeliness. They also examine how the preceding association varies by audit firms size, client size, and audit office industry specialization. Finally, they examine if partner rotation effects on audit fees and audit report lag persist over successive partner rotations. The SEC tightened partner rotation regulations in the Sarbanes-Oxley Act of 2002 with the hopes of quicker turnover bringing a fresh perspective to, and enhancing the independence, of the audit. The accounting profession opposed the new rules, arguing that, in addition to deterioration in audit quality, there would be significant effects on audit costs and effort, learning and training costs, loss of client-specific expertise, and inefficiencies affecting both the client and auditor. To the knowledge of the authors, there had been no empirical evidence that examined the impact of partner rotation on audit production under the mandatory rotation regime at the time this article was written. 

    Design/Method/ Approach:

    The authors draw upon and utilize a method to identify partner rotation in the U.S. following Litt et al. (2014); however, they extend this study by also examining if the audit cost effects of partner rotation persist over successive audit partner rotations. The authors design tests to examine if partner rotation costs persist at each rotation, and if client-specific knowledge at the audit firm level could potentially mitigate loss of client-specific knowledge and partner rotation costs at the partner level. This design provides a relatively long-term perspective on the consequences of a series of partner rotations and addresses some challenges to partner rotation studies. 

    Findings:
    • The authors find a positive and significant association between partner rotation and audit fees.
      • When the sample is segregated by auditor size and client size, they find significant positive associations for larger clients and non-Big 4 audit firms.
    • The audit timeliness results also show a positive and significant association between audit partner rotation and audit report lag for the full sample.
    • Similar to the audit fee results, the authors detect a significant and positive association between partner rotation and audit report lag for clients of city industry non-specialist auditors.
    Category:
    Audit Team Composition
    Sub-category:
    Partner Rotation
  • Jennifer M Mueller-Phillips
    Does Audit Fee Homogeneity Exist? Premiums and Discounts...
    research summary posted October 29, 2013 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    Does Audit Fee Homogeneity Exist? Premiums and Discounts Attributable to Individual Partners
    Practical Implications:

    The results of this study point to further complications that could arise from mandatory partner rotation policies. Because the assumption underlying this policy is that all partners from any given firm are interchangeable and that the benefits of enhanced auditor independence are not expected to lead to negative consequences for the client, this study creates a conflict. The author found that different partners from the same firm do provide different levels of quality in the eyes of the client which lead to discounts and premiums in audit fees. As a result, partner rotations could lead to unforeseen costs including clients having to switch audit firms to find the preferred level of quality as well as audit firms trying to poach partners from competitors in order to satisfy clients. These added costs should be considered when assessing the value of partner rotation policies.

    For more information on this study, please contact Stuart D. Taylor.
     

    Citation:

    Taylor, S. 2011. Does audit fee homogeneity exist? Premiums and discounts attributable to individual partners. Auditing: A Journal of Practice and Theory 30 (4): 249-272.

    Keywords:
    auditing; audit fees; audit partners; partner rotation.
    Purpose of the Study:

    Previous studies have suggested that client management chooses a level of audit quality and the related audit fees solely to satisfy the users of their financial statements. This study suggests that while satisfying financial statement users is an important factor in auditor selection, it is not the only reason for choosing a certain auditor. Furthermore, previous studies on auditor behavior imply that audit partners within the same firm provide statistically identical qualities of work, known as the “homogeneity assumption.” This study suggests that different auditors within the same firm provide differing levels of audit quality in the perception of client management and the audit partner plays a significant role in choosing an auditor.  There are costs and benefits of engaging different auditors, even different audit partners within the same audit firm, that exist in client management’s selection of auditors even if they are not valued by the financial statement users.

    Design/Method/ Approach:

    The author chose to conduct the research for this study using Australian publicly listed companies for the year 2005.  The Australian audit market was ideal for this research because disclosure of the name of the audit engagement partner in the audit report is required. The author used publicly available data to gather empirical evidence.

    Findings:
    • The empirical results indicate that individual audit partners earn individual audit fee premiums or discounts that can’t be explained by the firm they belong to.
    • Partners can earn significantly different levels of premiums and discounts at both Big 4 and non-Big 4 firms.
    • Cases of partners that receive fee premiums and discounts exist within the same audit firm.
    • Office level industry specialization where the partners are based does not explain the discounts and premiums.
    • Partners that receive audit fee premiums audit fewer clients and tend to have a shorter tenure than partners who receive a discount.
    • The author describes the partners that receive premiums with a shorter tenure as “rising stars” who are steadily moving from smaller to larger and more prestigious clients while the partners that receive discounts are not able to establish such a reputation and are only able to secure smaller clients.
    • If the audit market were to be solely driven by the financial statement users, one would expect that the market would consist of two completely separate classes of auditor, Big 4 and non-Big 4. However, the market price for audits is driven by both the demands of financial statement users and by the demand for a particular level of quality of audit process from client management.
    • Audit quality in the perspective of client management, apart from that for financial statement users, includes auditors that provide more efficient and less disruptive audits, will provide more informative management letters, or provide advice on certain matters.
    • The needs of financial statement users relate to the premiums and discounts to engaging a Big 4 as opposed to a non-Big 4 auditor. The demands of client management relate to the premiums and discounts paid for different audit partners. 
       
    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes, Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Auditor Qualifications (e.g. size - industry expertise), Partner Rotation
  • Jennifer M Mueller-Phillips
    The Association Between Audit Partner Rotation and Audit...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    The Association Between Audit Partner Rotation and Audit Fees: Empirical Evidence from the Australian Market
    Practical Implications:

     The results of the study have important implications for regulators, auditors, and companies. In recent years, audit partner rotation has increased due to mandatory rotation legislation in Australia and has led to increased monetary and social costs. This study identifies the extent to which auditors pass on these costs and the relative bargaining power between an audit firm and a client, which varies across different segments of the market. This study also makes several contributions to existing literature. Specifically, this study informs the debate on the costs and benefits of audit partner rotation by focusing on the financial costs of partner rotation in the form of increased audit fees. Further, this study extends prior research that examines the impact of mandatory and voluntary partner rotation and the association between audit fees and partner rotation in different market segments. In addition, this study informs policy makers and regulators on whether and in which context the costs of audit partner rotation are passed on to clients as increased audit fees.

    Citation:

     Stewart, J., P. Kent and J. Routledge. 2016. The Association Between Audit Partner Rotation and Audit Fees: Empirical Evidence from the Australian Market. Auditing, A Journal of Practice and Theory 35 (2): 181-197.

    Keywords:
    Audit partner rotation, audit fees, voluntary partner rotation, mandatory partner rotation, audit markets
    Purpose of the Study:

     Audit partner rotation has become an accepted practice in many jurisdictions as a means of enhancing audit independence. Both regulators and professional bodies believe that greater auditor independence should lead to improved audit quality and hence improved financial reporting quality. A number of studies have examined the benefits of partner rotation in terms of its impact on audit quality, but these studies have produced mixed results and the benefits of the practice have been questioned. Given the concern that audit partner rotation may not improve audit quality, it is appropriate to consider the impact of partner rotation on audit costs and whether any increased costs are passed on to the client. This study seeks to examine the direct relation between audit fees and partner rotation using data from Australia where mandatory partner rotation after 5 years was introduced in 2006.

    Design/Method/ Approach:

     The authors used a sample of publicly traded companies selected from those listed on the Australian Securities Exchange (ASX) in 2007 for this study. Details of audit partner rotation and financial and nonfinancial data were then collected from Morningstar DatAnalysis, Connect 4 Annual Reports Collection, or company annual reports for the years 2007-2010. The authors used this information to evaluate the relation between audit partner rotation and audit fees in the year of rotation and the two years post rotation. The impact of audit partner rotation was examined as either mandatory or voluntary. The data was also examined based on stratification into three groups: large global clients, mid-level clients, and small local clients.

    Findings:

    The results indicate that audit fees are higher in the year of partner rotation and the higher fees persist in the first year post rotation and, to a lesser extent, in the second year post rotation. Further, the results indicate the following:

    • Higher audit fees are associated with both mandatory and voluntary rotations in the year of rotation and with voluntary rotation in the first year post rotation.
    • Stratification of the sample shows that mandatory and voluntary rotations are associated with higher audit fees for the large global segment but only voluntary rotation is associated with higher audit fees for the small local segment. No association between audit fees and rotation was found for the mid-level market segment. 
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Audit Partner Rotation, Impact of SOX
  • Jennifer M Mueller-Phillips
    U.S. Audit Partner Rotations
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 05.03 Partner Rotation 
    Title:
    U.S. Audit Partner Rotations
    Practical Implications:

    This study helps to inform about the effects of audit partner rotations. The evidence suggests that partner rotation does add a fresh look at U.S. audit engagements. The results can also be applied to the U.S. debate over audit firm rotation. It demonstrates that firm rotation is not the only way to add a fresh look to audit engagements and that the current system of audit partner rotation already has a measurable effect.

    Citation:

    Laurion, Henry, A. Lawrence, and J. Ryans. 2017. “U.S. Audit Partner Rotations”. The Accounting Review. 92.3 (2017): 209. 

    Keywords:
    U.S. audit partner rotations; fresh look; restatements; valuation allowances and reserves; write-downs; special items
    Purpose of the Study:

    Currently, the SEC requires that lead partners rotate off an audit engagement after five years and then sit out another five years before returning to the audit engagement. The audit partner rotation requirement was put into place to add renewed professional skepticism and a fresh insight into the audit. Previous studies in the United States generally indicate that partner rotation decreases audit quality due to a loss of client-specific knowledge and expertise. This paper adds to the discussion by examining the incidence of restatements, write-downs, and special items, as well as changes in valuation allowances and reserves surrounding partner rotation.

     

    Design/Method/ Approach:

    The authors identified audit partner rotations by using SEC comment letter correspondences for issuers who have received comment letter reviews in two consecutive years that copy different audit partners for each of those years. The information was gathered using the Audit Analytics Comment Letter database and comprised of 205 U.S. partner rotations at 189 SEC public companies from 2006 to 2014. A difference-in-differences model was used to compare the before and after results against a non-rotating firm control group. 

    Findings:

    The authors find the following:

    • There is no change in the frequency of misstatements after a partner rotation.
    • However, restatement discoveries and restatement announcements display relative increases of 5.9% and 5.1% respectively after there is a new lead partner. This suggests that the audit partner rotation requirement does in fact increase audit quality.
    • Additionally, there is some evidence of decreases in positive special items.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Independence & Ethics
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